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ECONOMICS 




MACMILLAN AND CO., Limited 

LONDON • BOMBAY • CALCUTTA 
MELBOURNE 

THE MACMILLAN COMPANY 

NEW YORK • BOSTON • CHICAGO 
DALLAS • SAN FRANCISCO 

THE MACMILLAN CO. OF CANADA, Ltd. 

TORONTO 



ECONOMICS 

AN INTRODUCTION 
FOR THE GENERAL READER 



BY 



HENRY CLAY, M.A. 



MACMILLAN AND CO., LIMITED 

ST. MARTIN'S STREET, LONDON 

191 6 






COPYRIGHT 



? 



TO 

ALBERT MANSBRIDGE 



PREFACE 

An apology is needed for adding another to the large 
number of books that attempt to deal with the whole 
subject -matter of Economics in a single volume. I offer 
two pleas in extenuation. The first is that nearly all 
existing introductions to the subject are intended primarily 
for the University student. The pious wish is generally 
expressed that they may be of use also to the general 
reader ; but the general reader's special needs and oppor- 
tunities are seldom borne in mind. His needs are different, 
inasmuch as he has not the guidance of a teacher and the 
leisure of the student ; on the other hand, his opportunities 
are some compensation for these disadvantages, since he 
has usually a practical interest in the economic system and 
an experience of its working, which the academic student 
lacks. It seemed, therefore, worth while to try to do for 
the economic organisation as a whole what Bagehot and 
Mr. Hartley Withers have done for a part of it, the credit 
system — to explain the principles of its construction and 
working in the language of ordinary life, and with reference 
to the experience and interests of the ordinary man. While 
it would need a Bagehot to succeed, I hope that the mere 



viii ECONOMICS 

attempt will have done sometliing to make it easier for 
the general reader to perceive the bearing of economic 
studies on the political and social problems in which he is 
interested. 

My second plea is that existing introductions to 
Economics give the student too little help in applying its 
conclusions, since they give too little attention to the most 
interesting and important part of the subject, that, namely, 
where it borders on the allied studies of Politics and Ethics. 
The instinct which leads the working-man in discussions 
on economic questions to return constantly to the ethical 
aspect of them is a sound one, and Economics will gain 
rather than lose in authority by discarding its Mid- Victorian 
pose of the one and only science of society. No study of 
Economics, therefore, it seems to me, is worth making 
which does not include some consideration of the relation 
of the economic organisation to political and ethical aims 
and standards ; which does not, in other words, indicate 
what light Economics can throw on Euskin's question, 
" What is Wealth ? " Hitherto economists have tended 
to confine themselves to explaining how the economic 
organisation works, postponing indefinitely the considera- 
tion of its political and ethical aspects ; moralists, on the 
other hand, have applied their rules to the criticism of the 
economic organisation without taking too much trouble to 
understand it first. The chapters of my book, therefore, 
deahng with the political and ethical aspects of the economic 
organisation, which to some may seem irrelevant, seem to 
me to deal, however inadequately, with the most important 



PKEFACE IX 

section of economic studies ; at the same time I hope that 
any moraHst who may take up the book will read the 
first nineteen chapters first. 

I am conscious that my first plea has lost much of its 
force by the pubhcation of Dr. Cannan's Wealth, and my 
second by that of Mr. J. A. Hobson's WorJc and Wealth. 
Unfortunately for me, I did not know that these books 
were being written ; they were not pubUshed until this 
book was almost completed, and I did not read them until 
it was quite completed. I trust that the importance of 
the subjects, and the differences in my treatment of them, 
will be considered sufficient to justify another book. 

I wish to acknowledge my debt to previous writers. 
If I do not go beyond a general acknowledgment, it is due 
not to any wish to conceal an obHgation, but solely to the 
impossibility, after seven years of teaching, of tracing to 
their sources all conceptions and arguments that I owe to 
other writers. It is easier to assess one's indebtedness to 
friends. Professor D. H. Macgregor has helped me with 
many difficulties. Mr. K. H. Tawney and Mr. G. H. 
Thompson read my first draft of Chapters II. to VI. and 
XII. and XIII., and helped me with their criticisms and 
suggestions. Mr. H. Sanderson Furniss read the whole 
of my manuscript with a care for which I cannot thank 
him sufficiently, and enabled me to remove a great many 
obscurities, errors, and other imperfections. My wife 
performed a similar service while the book was being 
written, and Mr. A. E. Zimmern when it was in proof. My 
thanks are due to the Tutorial Classes Committee of the 



X ECONOMICS 

University of Oxford for relieving me of lecturing work, 
and so enabling me to give the book the revision for whicli 
it bad been waiting a year. And I tbank, though they are 
too numerous to mention by name, all the members of my 
classes, who have allowed me to draw on their wide and 
diverse industrial experience, and have helped me with 
their criticisms of the views, my own and other people's, 
that I have put before them. 

H. C. 



CONTENTS 



Chapter I. — Introbttctory 

PAGE 

1. The Scope and Subject-matter of Economics . . 1 

2. The Relation of Economic Study to Business Experi- 

ence ........ 6 

3. The Method of Economics . . . . . 9 

4. The Limits of Economics . . . . .16 

Chapter II. — The Division of Labour 

1. The Economy of Specialisation . . , .22 

2. Machinery ....... 25 

.S. The Localisation of Industries . . . .29 

4. Large-scale Production, and the Limits of Specialisa- 

tion ........ 33 

5. The Evils of Specialisation . . . 41 

Chapter III.— The Organisation or Production 



1. The Co-ordination of Specialists . 

2. The Functions op the " Middleman " . 

3. Methods of appointing the Organisers of Production 

4. Merits and Defects of the System of " Free Enter 

prise " . . ■ . 

Chapter IV. — Speculation and Insurance 



49 
51 

57 

62 



1. Production as a whole carried on in Anticipation of 

Demand ....... 68 

2. Speculative Dealing ...... 71 

3. The Use of Contracts to shift Speculatu/e Risks on to 

THE Shoulders of Dealers . . . .78 

xi 



xii ECONOMICS 

PAGE 

4. Tbkminal Markets for dealing in Futures . . 83 

5. Illegitimate Speculation . . . . .89 

6. Insurance and other Methods of meeting Risks . 94 



Chapter V. — Capital and its Organisation 

1. Functions of Capital in Modern Industry and Com- 

merce ....... 98 

2. Conditions requisite for the Accumulation of Capital 101 

3. Different Types of Organisation for applying Capital : 

THE Private Firm, the Joint Stock Company, Co- 
operative and Public Enterprise . . .103 

4. The Market for Capital . . . . .112 

Chapter VI. — Competition and Association 

1. The Pervasive Influence of Competition . .114 

2. Conflicting and Common Interests arising from 

Competition . . . . . .119 

3. Combination and Trade-Unionism ; the Co-operative 

Movement and Municipal and National Trading 123 

Chapter VII. — Monopoly and Combination 

1. In certain Industries Economy and Efficiency can be 

secured only by monopolistic control . . 131 

2. Railways may be classed with these Industries . 135 

3. Methods op Social Control of these Industries . 138 

Chapter VIII. — Monopoly and Combination {continued) 

1. The Tendency to Monopolistic Combination . . 146 

2. Conditions favourable to Monopolistic Combination 153 

3. Difficulties of Monopolistic Combinations . .155 

4. Advantages op Monopolistic Combination . . 158 
6. Vertical Combination ..... 162 

Chapter IX. — Money 

1. Money and Coinage ....•• 163 

2. The Single Standard . . . . c . 168 



CONTENTS xiii 

PAGE 

3. Gbesham's Law . . . . . . • 172 

4. Paper CuEREKcy . . . . . .174 

Chapter X.— Banking and Credit 

1. The Cancelling of Indebtedness by the Use of Credit 

Instruments . . . . . .180 

2. The Creation of Credit by Banks . . .188 

3. The Cash Reserve . . . . . .192 

4. The Social Utility of the Credit System . . 199 

Chapter XI. — The Level of Prices and Foreign 
Exchanges 

1. The Measurement of Changes in the Level of Prices 207 

2. Causes of Changes in the Level of Prices . . 210 

3. The Law of Comparative Cost .... 216 

4. Imports paid for by Exports . . . . 220 

5. The Balance of Trade and the Level of Prices . 222 

Chapter XII.^The Circulation of Wealth 

1. Wealth and Production ..... 227 

2 Income and Capital ...... 231 

3. Spending and Saving ...... 234 

4. The National Dp/idend or Income . . . 237 

Chapter XIII. — Unemployment and Over-Production 

1. Imperfect Co-operation between Specialists . , 244 

2. Imperfect Anticipation of Demand . . 248 

3. Cyclical Trade Fluctuations .... 252 

Chapter XIV. — Value ^ , 

1. Value and Price ...... 258 

2. The Labour Theory of Vai.ue .... 261 

3. The Cost of Production Theory of Value . . 266 

4. Decreasing, Increasing, and Constant Cost . . 273 

5. Influence of Competition and Monopoly on Value . 279 



xiv ECONOMICS 

PAGE 

Chapter. XV. — Value (continued) 

1. Relation op Utility to Value .... 284 

2. The Marginal Utility Theory of Valxje . . 287 

3. The Law of Supply akd Demand .... 292 

Chaptee XVT. - -Wages 

1. Wages and Income ...... 297 

2. Wages and Labour Cost ..... 302 

3. Wages and Trade Unionism^ .... 304 

Chapter XVII. — Wages (continued) 

L The Subsistence Theory of Wages . . . 308 

2. The Wages Fund Theory of Wages . . . 310 

3. Productivity Theories of Wages .... 313 

4. The Influence on Wages of the Standard of Life . 321 

5. The Influence on Wages of the Volume of the 

National Dividend ..... 328 

6. The Influence on Wages of Inequality of Opportunity 330 

7. Summary . . - . . . . . 332 

Chapter XVIII. — Interest and Profits 

1. The Distinction between Profits and Interest . 335 

2. Why is Interest paid ?..... 341 

3. What determines the Rate of Interest ? . . 346 

Chapter XIX. — Rent 

1. The Ricardian Theory of Rent .... 350 

2. The Law of Duhnishing Returns or Increasing Cost . 353 

3. Rent and Cost of Production .... 356 

4. Application of the Ricardian Theory to Actual Con- 

ditions ....... 360 

Chapter XX. — Rent (continued) 

1. '■ Rent " Elements in Wages .... 364 

2. " Rent " Elements in Profits and Interest . . 368 

3. Social Implications of the Ricardian Theory of Rent . 374 



CONTENTS XV 

PAGE 

Chapter XXI. — The State and the EcoNoivnc Organisation 

1. Private Property and Freedom of Enterprise . 379 

2. State Regulation and Supersession of Freedom of 

Enterprise ....... 384 

3. Taxation ........ 390 

Chapter XXII. — The State and the Economic Organisation 

(confimied) 

1. The Assumptions of the Present System . 395 

2. The Assumption op Rational Self-interest . . 397 

3. The Assumption that Competition leads to the Sur- 

vival of the Fittest ..... 399 

4. The Assumption that Wealth will usually be associ- 

ated WITH Social Service .... 402 

6. The Assumption that Market Value is a Satisfactory 

Indicator for Production to follow . . 409 

Chapter XXIII.— Wealth and Welfare — the Measure- 
ment OF Wealth 

1. Wealth as Product ...... 415 

2. Wealth as Welfare ...... 420 

3. Defects in the Usual Method of Computing the 

Country's Wealth ..... 423 

Chapter XXIV. — Wealth and Welfare — Economic 
Influences on Welfare 

1. The Influence of Distribution .... 429 

2. The Influence of the Use of Wealth and the Kind of 

Product . . .... 432 

3. The Influence of Work ..... 436 

4. The Sacrifice of Producer to Product . . 440 

Chapter XXV. — Wealth and Welfare — Business and 
Morality 

1. Welfare regarded as Independent of Wealth in some 

Systems of Morality ..... 447 



xvi ECONOMICS 

PAGE 

2. The Economic Obganisation not necessarily a Re- 

flection OF Current Moral Standards . . 450 

3. Reaction of the Economic Organisation on Moral 

Standards ....... 455 

4. Materialistic Tendency of Economic Influences 

To-day 460 

5. How Wealth contributes to Welfare . . . 464 

6. " Business is Business," and Economic Laws . . 468 

7. The Mobalisation of the Economic Organisation . 473 



CHAPTER I 



INTRODUCTORY 



The Scope and Subject-matter of Economics 

Economics is the study of business in its social aspect ; 
the word " business " being used in its broadest sense ^ to 
cover all lawful ways of making a living. It will help us 
to reach a clear understanding of the scope and objects of 
the study if we take an example of the simplest kind of 
business transaction, and remind ourselves of the social 
"-'•-.ngements which make the transaction possible. 

We wiU take the purchase of a woollen shirt, the price of 

•jic' is ten shillings. We notice first of all that it is not 

.: d' n the home, as it would have been a couple of genera- 

ions ago ; it is less trouble to buy it from an outfitter. The 

; : Gt- er did not make it ; he bought his stock of shirts 

; • - :, shirt manufacturer, or possibly from a warehouse- 

'ho bought them from a manufacturer. When we 

■ t' ; shirt manufacturer " made " the shirts, however, 

. •: (i ' not mean that he made the material of which the 

.re made ; he may have done so, but more probably 

'■:-' :■ iness was confined to " making up " material which 

- • ■;<_ _ght from a piece-merchant or flannel manufacturer. 

IS 1 B 



2 ECONOMICS CHAP. 

From other merchants or manufacturers he would buy 
the thread, buttons, and material for collar-bands. The 
flannel manufacturer would use several kinds of yarn in 
making his flannel, and each of these yarns would be spun 
from several kinds of wool. The origin of the shirt, then, 
which we obtained by the simple process of handing a ten- 
shilKng piece over a counter, is to be sought on the York- 
shire hills, the Murray River sheep-runs and the South 
American plains, where the wools were grown, in the cotton 
plantations of the United States which supphed the raw 
material for the thread and collar-band, and in Birmingham 
where the buttons were made. In the course of its jom-ney 
from the sheep's back to ours, the wool has probably 
travelled through three or four factories, through a dozen 
middlemen's hands and half round the globe. It is one 
item in the output of an organisation, the woollen industry, 
the ramifications of which reach most parts of the civihsed 
world. 

The woollen industry was not the only organisation 
involved in the production of the shirt, and necessa^ry to 
its production on the modern system. Each of the factories 
through which the material passed required for its work 
on the material many machines, which in their turn required 
power to drive them. Several branches of the machinery 
and engineering industries were therefore involved in the 
making of this shirt ; so were the iron and steel industries 
which supplied the material of these machines ; so wer 
the oil and leather industries, since they supplied subsidiary 
materials. The coal industry was involved, because coal 
is the chief source of power ; the building trades, because 
modern factories and warehouses have to be built specially 
for their work. The more important forms of transport 
were all of them employed in the making of this shirt. 



I INTRODUCTORY 3 

since its materials came from so many different quarters, 
and were shaped and put together in so many different 
places. The credit system was probably involved, since 
some of the firms that handled it would be dependent on 
assistance from banks to carry on their business, and the 
movement of raw materials is very largely financed by bills 
of exchange. It would hardly be too much to say that the 
apparently simple transaction of purchasing a shirt was 
the completion of a process in which the modern economic 
system as a whole was involved. 

Moreover, when we spoke of the parts of that system, 
manufacturers and merchants, transport agencies and the 
credit system, we were referring summarily and simply to 
things which in themselves are complex. The flannel manu- 
facturer employs eleven or twelve different kinds of worker 
in four departments, even if he neither spins his own yarn 
nor dyes his own pieces ; the clothier employs ten different 
kinds of worker on three or more different machines in five 
or more departments ; transport agencies vary from the 
country carrier with a horse and cart to railway companies 
with 70,000 employees and £100,000,000 capital ; even the 
merchant, who employs directly only half a dozen clerks in 
a modest office, may be the meeting-point and support 
of a network of trade connexions covering a continent ; 
even the outfitter's business requires an expert. The 
shirt, then, which we purchase with so little thought, is a 
product of the most complicated piece of social organisa- 
tion that mankind has yet devised. Our attempt to get 
behind the superficial simpHcity of our business transactions 
has entangled us in a labyrinth, the paths of which lead 
into every social class, and has involved us in a study of a 
large part of the activities of the human race. 

This system of social arrangements, the existence of 



4 ECONOMICS CHAP. 

whicli is revealed by the analysis of any business trans- 
action, is the subject-matter of Economics ; it is the object 
of Economics to explain the arrangements in detail and to 
show how the system works. The example we have taken 
(and any other would have served as well) justifies the use 
of the word " system." At first sight the business world 
offers a spectacle of confusion rather than order. We 
found however that things did not happen anyhow. The 
materials of which our shirt was made could not have found 
their way from the place of origin, through all the processes 
of manufacture, to the outfitter's hy accident. There was 
order in the process : the outfitter's shop, the shirt-maker 
and the other firms concerned were parts of a working 
system ; our transaction was one of millions which depend 
on one another. Our glimpse of the working of the system 
gave the impression of a great automatic machine. The 
system is not a system like the political system, which has 
a sovereign directing authority. It is not the work of a 
single brain or the embodiment of a single purpose ; it is a 
spontaneous organisation, the outcome of actions which 
were not consciously directed to establishing or maintaining 
it. Hence, although we are parts of it, we can study it 
objectively, like a piece of external nature, and search for 
the principles of its structure and working as the physi- 
ologist searches for the principles of the structure and 
working of the human body. What points of contact this 
economic order has with the political order, and how far it 
harmonises with the moral order, are questions we can ask 
when we have examined it and ascertained its principles. 

The example we took will illustrate also the interest and 
importance of Economics. Why was the shirt ten shilhngs ? 
Why did the outfitter charge us no more ? How is it that 
we could not get it for less ? Who gets our ten shillings 



I INTRODUCTOEY 5 

and all the otlier sliillings paid for shirts ? In what pro- 
portions is the price divided among the difierent firms 
which handled the goods ? and, within each firm, between 
operatives and employers ? On what principle does this 
division take place ? These are questions which every one 
tries to answer at some time or other, and Economics is 
only a systematic attempt to answer these and related 
questions. How do the many firms which contribute to 
the making of the shirt manage to carry on between the 
time when they incur the expense of making the shirt and 
the time when the user pays for it ? How are payments 
made in America and Australia for goods sent to England, 
and what difference would a protective duty on all imports 
into England make on the course of trade ? What would 
be the effect on the price of shirts of a rise in wages, or a 
new tax on profits or rents ? What would be the effect of 
extending the Trade Boards (Minimum Wage) Act to cover 
all the industries concerned in the making of a shirt ? or of 
the formation of a " combine " of shirt-makers or flannel 
manufacturers ? Is a " combine " probable in either of 
those industries ? Under what conditions is an industry 
likely to be " trustified " ? These are less obvious problems 
which our example presents — less obvious, but still the 
kind of questions that the investor, the trade union official, 
and every citizen who uses his vote intelligently is con- 
stantly being called upon to face ; and all of them fall 
within one or other of the more important sections of 
Economics. 

The system works ; and even if we take its working 
for granted without enquiring how it works, its defects 
compel study. Unemployment, speculative gambling, 
waste and poverty, are results of it obvious to the most 
superficial observer. Are these evils inevitable ? If they 



6 ECONOMICS CHAP. 

are, what advantages does the system ofier to counter- 
balance them ? if not, why are they there ? Above all, 
what is one's personal responsibility in the face of these 
evils ? Economics is the systematic study of these questions. 
Some study of Economics is at once a practical necessity 
and a moral obligation. And as a matter of fact everybody 
makes some such study, everybody at some time or other 
is a student of Economics, an economist ; like M. Jourdain, 
who was surprised to learn that he spoke prose, the general 
reader may not have realised that he was an economist. 



II 

Relation of Economic Study to Business Experience 

Every one, then, makes some study, more or less casual 
or systematic, of the subject-matter of Economics ; and 
every adult has one important qualification for such study, 
namely experience. It is on the basis of their experience 
of the present economic system that people form their 
judgment on its problems ; it is in their experience that 
they find the materials for answering such questions as 
arose from the example we took of an economic transaction. 

Experience, however, while it is a qualification, and an 
essential qualification, for the study of economic problems, 
cannot be an adequate substitute for that specialised and 
systematic study of them which constitutes the science of 
Economics. It is easy to be familiar with a thing, and 
even to work with it, without understanding it. The 
engine-driver can do his work excellently without knowing 
anything of the science of thermo-dynamics, and most of 
us succeed in spending a lifetime with our bodies without 
acquiring any considerable knowledge of tlie science of 



I INTEODUCTORY 7 

human physiology ; similarly a man may be a good business 
man and yet a bad economist. The experience which any 
one man, or even any one social class, gains of the economic 
system in the course of everyday life and work is limited. 
So far as it goes, it is a sound basis for economic judgments ; 
but a thorough practical acquaintance with banking would 
not help a man much to understand the organisation of a 
colliery, an intimate knowledge of the building trade would 
not fit a man to understand, either in their private or their 
social aspect, the operations of a Liverpool cotton-broker. 
To find a secure basis for an understanding of the economic 
system it is necessary to bring together the experiences of 
all trades and occupations, of manual worker and industrial 
organiser, of private industry and government service, of 
housewife and producer ; the experience of any individual 
or class is too limited to give by itself anything but a 
hmited and partial insight into the system as a whole. 

Moreover, the understanding of the system that a man 
gains from the experience of being a part of it is more of 
the nature of instinct than knowledge. It enables a man 
to judge and act ; it does not enable him to explain always 
how he judges and why he acts. If forced to give an ex- 
planation, the explanation may be a wrong one ; copy- 
book maxims about industry and early rising have a 
suspiciously large place in the explanations given by self- 
made men of their success ; luck and a lack of scruple, 
though at least as important, are never mentioned. Thus 
the experience of people actually engaged in industry has 
to be subjected to their own reflection and studied from 
outside, to be analysed, before it can add anything to the 
body of knowledge which all may share who are willing to 
study ; treated in that way it becomes the most valuable 
of all sources of knowledge. 



8 ECONOMICS CHAP. 

Individual experience is limited and unconscious ; it 
lias to be supplemented by Economics for a more important 
reason. Its point of view is that of the individual, the 
point of view of Economics is that of society. Every 
business transaction has more than one aspect. The indi- 
viduals who are parties to it are interested chiefly in its 
private aspect ; Economics is concerned with its social 
aspect, which may be a different thing. From the point 
of view of the individual^ profits are the difference between 
his expenses and his receipts ; from the point of view of 
society, they are the incentive to, and the payment for, 
organising work ; the individual is concerned only with 
their amount, society with their origin and the extent to 
which they elicit and represent services to society. Specula- 
tion, from the point of view of the individual, is the act of 
buying at one time and selling at another, and is justified 
if the seUing price exceeds the buying price ; from the 
point of view of society^ it is the process by which fluctuating 
supplies are adjusted to a fluctuating demand, and is justi- 
fied (or the reverse) by its influence on price fluctuations. 
To the individual it may make little difference whether he 
increases his profits by higher prices on a smaller output 
or by a larger output at lower prices ; society is keenly 
interested to learn under what circumstances the former 
method is Hkely to be adopted and under what circumstances 
the latter. There is the same difference between the two 
views as there is between the view of a town which a man 
gets from his street-door and the view he would get from 
an air-ship. No one, unfortunately, can lift himself into a 
position to take an " air-ship " view of society ; so that the 
economist, and other students of society, have to construct 
their " air-ship " view of society by collecting, comparing 
and relating a large number of street-door views. 



I INTRODUCTORY 9 

Economics, we have said, is the study of business in its 
social aspect, and the point of view is fundamental to the 
study. Business in its private aspect is so much a matter of 
personal character and accidental circumstances, that only 
a very small part of it can be reduced to rule or stated 
in systematic form. University courses and even degrees in 
" Commerce " can now be taken, but the study of Economics, 
as defined above, can help the futvire business man only by 
making him more interested in business and therefore more 
hkely to devote his undivided energies to it. From the point 
of view of society's interests, however, it is very desirable that 
business men should study Economics, since it is to society's 
interest that they should reflect on and realise the social 
effects of their private actions. For the same reason, that 
the private and the social aspects of business are so often 
different, a " government of business men " — if the phrase is 
intended to be understood in a narrow sense — would be a 
bad government. It would apply to the work of govern- 
ment standards and tests derived from private industry 
that are not apphcable to public services ; it might forget 
that it often " pays " a government to rim a public service 
(such as sanitation or education) " at a loss." 



Ill 

The Method of Economics 

The study, then, of our subject-matter, in which every 
one at some time or another engages, can be supplemented 
with advantage by the specialised and systematic study of 
it, which we call Economics. The latter grows out of the 
former, the former is the best preparation for the latter. 
And the method of the unconscious and unsystematic study 



10 ECONOMICS CHAP. 

is the metliod, used deliberately and consciously, by which 
the systematic study reaches its conclusions. That method 
is — to reflect ; to generalise on the basis of the known 
facts ; in the light of the generalisation to collect further 
facts with which to test it ; and by this process of testing, 
and by comparison with other generalisations reached by 
the same process, to reach a generalisation which exactly 
fits the facts. By this method any one who is forced by 
circumstances to frame an answer to some economic 
problem brings his experience and casually accumulated 
knowledge to bear upon it ; by this method Economics 
seeks to reach and to state the principles of the present 
economic system. 

Economic Theory is the body of generalisations so 
reached. The practical man is suspicious of " theory." 
His suspicion is justified, if " theory " is used as a sub- 
stitute for ascertainable facts. But generahsation, the 
making of theories, is unavoidable. Facts do not explain 
themselves. In some problems, the causes of trade fluctua- 
tions for example, the multitude of facts is so great that we 
cannot even begin to collect them unless we collect on some 
plan ; we shall be overwhelmed if we do not take with us 
to the facts some co-ordinating idea, in other words if we 
do not frame a theory and take it to the facts to test it by 
them. On some important questions we cannot hope to 
enumerate all the ascertainable facts ; if we wait to form 
our judgment on the influences that fix wages until we 
have examined all the ascertainable facts, we shall never 
form a judgment, their number is so great. On other 
problems some decision has to be reached for purposes 
of action, although facts are scarce or imobtainable ; 
taxes are often based on theories which it has been 
impossible to verify, the collection of the taxes sub- 



I INTKODUCTORY 11 

seqiiently eliciting the facts that are needed to verify the 
theories. 

Again facts may be contradictory, at any rate on the 
surface : it is a fact that the introduction of labour-saving 
machinery has on many occasions displaced labour ; it is 
also a fact that the amount of labour-saving machinery in 
use has steadily increased for generations without being 
accompanied by any corresponding increase in the propor- 
tion of the population unemployed. Or the facts may 
bear more than one interpretation. There are several 
conflicting theories of wages, all of them " based on facts " : 
for example, according to the theory on which English 
Poor Law policy is based, any subsidy to the wage-earner 
from the State wiU force wages down; according to the 
theory on which the feeding of school-children and old 
age pensions are based, State subsidies have no effect, or 
only a negligible effect ; some facts can be found to support 
either theory. On the same foundation of facts different 
statesmen have based two entirely different fiscal policies 
in regard to foreign trade. Facts are seldom simple and 
usually complicated ; theoretical analysis is needed to 
unravel the complications and interpret the facts before 
we can understand them. 

The practical man's objection to " theory " is a valuable 
protest against hasty generalisation on an insufficient basis 
of fact or on an inadequate survey of available facts. But 
the opposition of " facts " and " theory " is a false one ; 
their true relation is complementary. We cannot in prac- 
tice consider a fact without relating it to other facts, and 
the relation is a theory. Facts by themselves are dumb ; 
before they will tell us anything we have to arrange them, 
and the arrangement is a theory. Theory is simply the 
unavoidable arrangement and interpretation of facts, 



12 ECONOMIC>S CRAP. 

which gives us generalisations ou which we can argue and 
act, in the place of a mass of disjointed particulars. What 
we are seeking in our study of economic problems, whether 
it is a conscious and systematic study or not, are principles. 
We want to know what, in the operations we observe, 
is the rule, what is the exception ; why certain arrange- 
ments are as they are, and what will happen if we change 
them. Unrelated facts will not answer our questions ; 
we want chains of facts, regularities, relations of cause and 
effect. We are seeking principles in order that we may 
act on them, because the ultimate motive of economic 
study is not curiosity, but the necessity to act, and rational 
action must be based on some principle. All arguments are 
based on principles, facts are of use only as they represent 
or illustrate principles. Economics, therefore, in order to 
discover the principles on which the present system is 
constructed and operates, surveys the facts of the system, 
arranges them, analyses them, generahses on the basis of 
them. Like every other science it advances by constantly 
discarding generalisations which newly discovered facts 
have revealed as unsound or inadequate, and devising new 
generalisations which will cover and explain the new facts. 
Conscious and deliberate theorising is necessary, because 
there is so much imconscious and haphazard theorising. 
The man who opens a discussion by saying that he is 
going to " deal with facts not theories " does not mean that 
he is going to refrain from generalisation ; he usually means 
that he wishes to confine attention to a few facts that 
support his generalisation, and to ignore all facts that 
conflict with it. The field of poHtical controversy is strewn 
with hasty generalisations treated as if they were estab- 
lished truths, and used as the basis of argument. " Trade 
follows the flag," " Wages depend on the cost of Uving," 



I INTKODUCTORY 13 

" The present competitive system," are examples ; and 
even more insidious are the theories of wages, profits, 
value, exchange, on which people base their judgment of 
economic problems without ever formulating them even to 
themselves. The time-honoured " Law of Supply and 
Demand " has been misused so long to justify quiescence 
in the face of obvious evils that a natural reaction has led 
to the view that it can be ignored. 

One of the great dif&culties of all study of which man 
and his activities are the subject-matter is that the student, 
being himself part of the subject-matter of the study, is likely 
to be influenced in his judgments by assumptions, based on 
interests and prejudices, of which he is unconscious. The 
danger is particularly great in the study of the economic 
system, and the most careful student can hardly hope to 
attain a perfectly impartial judgment. It is doubly import- 
ant, therefore, that economic theorising should be carried 
on " in the open," that the assumptions underlying economic 
policies should be brought to light, and the " views " (or 
unconscious theories) on which people in practice base 
their judgment of problems of wages, prices and other 
things, should be stated explicitly, in order that they may 
be critically examined. If everybody is, as has been said, 
an economist, certainly everybody has his own economic 
theories ; if those theories are not formed by conscious 
and deliberate study, they will be based on a limited 
experience and on prejudices, interests, ideals, which mis- 
lead the judgment just because they are unsuspected. 
An incidental advantage of deliberate study is that it leads 
people to define their terms. Such words as Wealth, 
Value, Profits, Monopoly, Competition, Co-operation, can 
be used in more than one sense each, and the different 
senses are not distinguished clearly in ordinary conversa- 



14 ECONOMICS CHAP. 

tion. Economics, by confining each word to a single sense, 
and defining that sense, makes progress in argument 
possible, and tends to prevent those lengthy controversies, 
so frequent in politics, which are lengthy only because the 
parties to them mean different things by the same words. 

The twofold difficulty of handling the multitude of 
available facts and collecting additional facts, where relevant 
and decisive information is not already available, has 
produced a tendency to split up the subject-matter of 
Economics into a large number of smaller studies. It has 
been possible by so doing to utilise more fully the collections 
of facts made by Government departments, royal com- 
missions and private enquiries, to supplement them, and 
so to deal exhaustively with particular problems, such as 
unemployment and the minimum wage, or particular 
developments of industrial structure, such as the trust 
movement and co-operation. Recent work in Economics 
of this character has had an immediate influence on social 
policy by indicating the need and method of particular 
reforms. Such enquiries, however, are supplementary to 
the study of the general characteristics of the economic 
system ; they aid it, they do not make it unnecessary. 
The different problems are interdependent, and can only 
provisionally be treated as separate and independent. 
Wages cannot be considered without some consideration of 
profits and rent, combinations cannot be studied without 
considering the nature and effects of competition ; the 
system of distribution is intimately bound up with the 
system of production. The secondary and less obvious 
results of changes, therefore, are often more important than 
the immediate and obvious results ; the reactions and 
repercussions of a new invention, or a piece of social legisla- 
tion, or an innovation in business organisation, may spread 



INTRODUCTORY [ 15 V 

far beyond the immediate objects to wbicli it is directed. 
The economic system, in fact, as our example showed, 
operates as a unity, although its unity may be made up of 
lesser imities ; and the relation of one part to another, the 
bearing of one problem on another, and the secondary 
effects of a limited reform can be understood only by 
studying the system as a whole. Some such attempt to 
understand the system as a whole is, as a matter of fact, 
made by every one ; society's economic arrangements so 
intimately affect the pohtical organisation of society and 
the moral Hfe of the individual that it is hard to reach a 
decision on any broad political or moral question without 
incidentally judging the economic system. 

The phrase, " a science of Economics,"' was used above. 
The claim of Economics to that description has been dis- 
puted. In the only sense of the word " science," however, 
that matters — the study of a group of problems, in which 
the solution of one assists in the solution of the others 
(J. Cook Wilson) — any study of society proves that 
Economics is a science. The objection is sometimes made 
that Economics cannot be a science because economists 
disagree. But doctors disagree, and no one denies that 
physiology and anatomy are sciences. There are disagree- 
ments in every science, yet in every science the advantages 
to be gained by specialised study have been proved by 
experience. Adam Smith is regarded as the founder of 
the science of Economics, because he perceived that there 
was a connexion between different economic problems, and 
at the same time that economic phenomena were largely 
independent of the political arrangements with which, up 
to his time, they were usually studied. He displayed more 
clearly than had been done before the social co-operation 
which results from the pursuit of their private interests by 



16 ECONOMICS CHAP. 

individuals, and so pointed the way to a specialised study 
of business in its social aspect. 



IV 

The Limits of Economics 

This separateness and independence of economic pheno- 
mena must not be exaggerated. The immediate successors 
of Adam Smith, under the influence of laissez-faire ideals, 
did so exaggerate it, although Adam Smith himself put 
forward his economics as part of a general study of moral 
and political philosophy; it is well, therefore, to recognise at 
the outset the limits of Economics. Economics is not a 
complete philosophy of society ; it does not give a complete 
account even of that part of human conduct which it studies. 
The social relations to which business gives rise are the 
subject-matter not only of Economics but also of the 
science of Politics, the study of social action in general, 
and of Ethics, the study of conduct in general. And 
Economics is the subordinate study of the three, because 
the problems of social practice to which its study is directed 
are seldom purely economic, and when it comes to action 
the ethical aspect is always, and the political aspect is 
usually, more important than the economic aspect. The 
study of the economic element in social and political 
problems is essential if they are to be solved, but few of 
them can be decided by purely economic considerations 
alone. 

An example or two will illustrate the distinction. The 
system of State regulation of industry and commerce 
known as the Mercantile System was condemned by 
Adam Smith, and shown by him to result in waste ; yet he 



I INTKODUCTOEY 17 

describes a part of the system, the Navigation Acts, as the 
wisest of all our commercial regulations, because he attri- 
buted English naval power to them and considered that 
the political principle that defence is more important than 
opulence overrode the economic consideration of waste. 
So an Englishman to-day might support Protection and 
Imperial Preference on purely economic grounds, thinking 
that such a policy would strengthen and increase British 
trade ; but he might advocate the same policy, while 
believing that it would result in a net loss of wealth to the 
country, on the ground that it would knit together the 
different parts of the Empire, and that such a political end 
was worth some economic sacrifice. A man may be a socialist 
on purely economic grounds, believing that an extension 
of State ownership would result in cheaper and better 
supplies ; but he may believe that State ownership would 
result in some waste, and still advocate its extension on 
the political ground that so important an influence on Hfe 
as the supply of the means of life should be democratically 
controlled, or on the ethical ground that competition as it 
works at present is immoral. So, again, a legal minimum 
wage, the pubHc provision of better housing, or improved 
free education may be advocated on the economic ground 
that they would increase eJBS.ciency and, in the long run, 
more than pay for themselves ; or on the ethical ground 
that society can afford them and ought to provide them, 
whether the result be economic loss or gain. 

Or we may put the relation between Economics and 
PoUtics and Ethics in another way. In every problem 
there are two questions — What is ? and What ought to be ? 
The problem can be dealt with only when both are answered. 
Economics is concerned chiefly with the first ; the second is 
(or should be) decided rather by a consideration of the 

c 



18 ECONOMICS CHAP. 

political and ethical aspects of the problem, because our 
poUtical and ethical opinions give us the ends of our actions. 
Where on poHtical or ethical grounds two or more alterna- 
tives are admissible, then the economic end of cheapness, a 
maximum return for a minimum of expenditure, may decide. 
In practice society does not accept this principle in its full 
rigour, but compromises between its ideals and cheapness ; 
in democratic countries we rest content with an ohgarchic 
organisation of industry for fear of " drying up the springs 
of wealth," and in Christian countries we apply the doctrine 
of brotherly love to economic relations only within Hmits, 
for fear of being forced ourselves to rely for a livelihood 
on the brotherly love of others. 

It should be noted that the object of Economics is not 
the advocacy of the present or of any other economic system, 
but explanation solely. In explaining, for example, that 
competition is the chief force controlling industry in the 
social interest, the economist is not saying that it ought 
to be, or that it is an ideal method of control. Explanation 
is not justification, a truth which the classical economists, 
in the excitement of discovering how the economic system 
worked, tended to forget. 

Not only is Economics a subordinate study, but its 
conclusions have a temporary application only ; they are 
not, like the conclusions of mathematics, true for all time 
and imder all circumstances. This is so because they aim 
at giving a systematic explanation of the social arrangements 
by which man satisfies his wants, and these arrangements 
are temporary and conditional. They depend very largely 
on the state of the physical sciences ; for any sudden 
increase in man's control over nature would be reflected 
in a changed social organisation. The social effects of the 
discovery of the use of coal as a source of power, of cheap 



I INTKODUCTOEY 19 

steel, of electric commimications, warn us against any 
attempt to forecast the future simply on a basis of the 
study of existing economic arrangements. The arrange- 
ments depend also on the possibilities of human nature. 
A religious revival, which made the motives of the early 
disciples the dominant motives of society, would produce 
a sudden rearrangement of economic institutions ; and a 
theory of distribution which gave a true account of incomes 
to-day would become suddenly false. Or a growth of 
civic patriotism, like that of the Athenians, would make 
possible economic arrangements which, as men are, would 
not work. Those economists who have approached the 
study of economic arrangements from the standpoint of 
psychology have concerned themselves more with measuring 
the strength of motives than with distinguishing and 
classifying the kinds of motives which actuate men in 
their economic relations and estimating their comparative 
importance. The latter is a field that needs exploration. 

In emphasising so strongly the Hmits of Economics we 
are not underrating its importance. We wish merely to 
guard against the confusions which invariably arise when 
some subject of everyday experience is subjected to scien- 
tific examination. The economist is constantly accused of 
saying that things ought to be as they are^ when he merely 
points out that they are. On the other hand, where his 
authority is recognised, he is constantly quoted as the 
final authority on all social questions, whereas Economics 
is concerned with only one aspect of social questions. 
Though subordinate. Economics is not unimportant. In 
answering the first of the questions that face us in every 
social problem — the question What is ? — Economics can 
give perhaps more help than any other study. The widely 
varying views of the nature of the economic system which 



20 ECONOMICS emu-. 

are lield by people who play an important part in working 
it are sufficient indication of the difficulty of the question. 
And it is as important as it is difficult. It is only by under- 
standing the present system that we can m^ake with a 
minimum of dislocation the transition to the different 
system which our political and ethical ideas dictate ; and 
the less the dislocation which a social reform involves the 
less is the danger of reaction following the reform. There 
is no need, however, to emphasise further the importance 
of the economic aspect of social arrangements ; everybody 
experiences it. And the economic end of cheapness or 
plenty is sufficiently important, even if it should not be 
allowed to dominate the whole of life ; while it should be 
kept in its place, it should never be forgotten. 

The advantage of isolating the economic aspects of 
society for separate study is that it conduces to clear 
thinking and a better understanding of the complexity of 
social relations. Its justification is the advance that has 
been made in the understanding of economic relations since 
Adam Smith made the study of them a separate science. 
In judicial procedure experience has taught the necessity 
of considering separately questions of fact and questions 
of law, although both are essential to the judgment ; 
similarly in social study, it is a help to consider questions of 
economic fact and questions of moral right separately, 
although our action will be influenced by the two considera- 
tions jointly. The separation assists in the constructive 
handling of the mass of facts which bewilder us at our first 
attempt to discover the principles of the social organisation. 
It prevents the confusion of thought and the argument at 
cross-purposes which inevitably result from the attempt 
to discuss all the aspects of a complicated question at once. 
Just as physiology, anatomy, and psychology study the 



I INTEODUCTORY 21 

same subject, man, from different points of view, bo the 
social sciences, economics, ethics, poHtics, and law, study 
different aspects of the same subject, society. The method 
is simply an application of the common-sense principle, 
" One thing at a time." Specialisation is as necessary in 
research as in industry ; the progress of knowledge has 
been based on the same principle as the growth of the 
Roman Empire, Divide et impera. The method has its 
dangers, since aspects of a problem that can be separated 
for study cannot be separated for purposes of action ; but 
the misuse of the conclusions of speciahsed study is no 
reason for giving up the study. 

The following pages will not answer all the questions 
that have been raised in this chapter ; considerations of 
space and the patience of readers forbid. What they 
attempt to do is to provide the general reader with a 
framework into which he can fit the facts and principles 
which he acquires in the course of his own experience, to 
put at his service some of the conceptions and lines of 
thought which students have found useful, and to intro- 
duce him to a systematic study of the more important 
questions which are raised by any attempt to understand 
present-day economic arrangements as a whole. 



CHAPTER II 



THE DIVISION OF LABOUR 



The Economy of Specialisation 

The clue to the labyrinth in which the attempt to analyse 
a simple business transaction involves the enquirer is 
given in the first sentence of Adam Smith's Wealth of 
Nations : " The greatest improvement in the productive 
powers of labour, and the greater part of the skill, 
dexterity, and judgement with which it is anywhere 
directed, or apphed, seem to have been the efiects of the 
division of labour." Others had seen that the division 
of labour was important ; Adam Smith first gave it its 
true place as the fundamental principle of economic 
organisation, and on that account perhaps put it at the 
very beginning of his treatise. The history of industry can 
be viewed as simply the ever-widening appKcation of the 
principle of the division of labour ; the latest economy in 
business organisation, the so-called " scientific manage- 
ment," is a conscious application of it. 

From the point of view of the individual the division of 
labour means specialisation ; from the point of view of 
society it means co-operation. The individual specialises, 
because by restricting his work to a single trade or a single 

22 



CHAP, n THE DIVISION OF LABOUR 23 

process lie can become more efficient at his work than he 
could be if it were more varied. But specialisation by 
individuals is practicable only in society. Some individuals 
can give their time exclusively to the provision of clothing 
or furniture, only because other individuals are directing 
their efforts to the provision of food and shelter. In an 
advanced industrial society every producer is a specialist 
in detail, because the society includes specialists in every 
other kind of work needed to satisfy the society's wants. 

Specialisation is fundamental in economic organisation, 
because it is the means by which man increases the return 
to a given amount of work. It brings about this result 
in two ways, by subdivision of tasks and by repetition of 
tasks. Subdivision results in operations easier in them- 
selves, repetition enables operations to be performed with 
greater ease. " Practice makes perfect " ; an operation, if 
repeated often enough, becomes a habit ; our bodies and 
brains adjust themselves to performing perfectly and 
without effort what at first is done only badly and with 
great effort. The estimation of forces and sizes, the exact 
co-ordination of hand and eye, called for by almost any 
craft, become instinctive by specialisation ; by practice is 
built up the specialised experience which is the explana- 
tion of achievement in all kinds of work — the craftsman's 
" sense " of the possibihties of his materials, the dealer's 
" instinct " for his market, the physician's " intuition " of 
disease, the connoisseur's " feehng " for quafity in the 
objects of his study. Delicate tasks come to be performed 
with accuracy, the speed of work is increased, the strain 
involved in the performance of any single task is reduced ; 
the routine of work is, in James's phrase, handed over 
'-' to the effortless custody of automatism." 

Specialisation can occur only in a society, and implies 



24 ECONOMICS chap. 

tlie habit of exchange. The direct exchange of goods for 
goods, and goods for services, is called barter, and is so 
clumsy a method of carrying on exchange that speciaHsa- 
tion could never have gone far without some medium of 
exchange which would obviate the clumsiness of barter. 
Such a medium of exchange is Money. Later we shall 
examine in some detail the qualities of a good medium of 
exchange, and the way in which money does its work. 
Here we need to notice only that such a medium of exchange, 
generally accepted and easily divisible, is necessary to 
enable individuals to specialise. So long as money was 
scarce in quantity and uncertain in quality, so long, that 
is, as exchanges had to take the form of barter, there was 
little specialisation. The great mass of people were agri- 
culturists raising their own living ; there were few special- 
ised workers ; trade was confined to luxuries and the small 
surplus of production over immediate local needs ; few 
people got more than bare physical necessities, and not 
even these with certainty. In the England of Elizabeth, 
in continental Europe until much later, as in Asia to-day, 
the great bulk of the population consisted of peasants 
engaged in subsistence husbandry. Even then, however, 
specialisation was the chief means of increasing wealth ; 
Adam Smith wrote before the Industrial Eevolution. 

The simplest form of the division of labour is the special- 
isation of individuals to single industries or trades. As 
soon as there was any surplus of produce over immediate 
local needs, the specialised trader arose to collect and 
distribute that surplus. A very small village community 
was large enough to enable individuals to devote them- 
selves exclusively to the work of the smith and corn-miller. 
The making of cloth, baking, the working of stone and 
leather difierentiate themselves early ; in a modern com- 



n THE DIVISION OF LABOUE 25 

munity the jobbing carpenter and tailor, tlie doctor and 
lawyer, tbe artist and priest represent this type of the 
division of labour. 

The next form of the division of labour, historically 
and logically, is the subdivision of one specialised craft 
into separate processes and the speciahsation of " detail " 
workers to each of these processes. Just as the working 
of metal wiU be done better by a speciahsed smith than 
iDy a comparatively unspecialised worker like a farmer, 
so the manufacture of any common metal object will be 
more rapid and efficient, if it is split up into several pro- 
cesses and a speciahsed worker set on each of these processes 
as his exclusive work. Thus the making of cloth became 
the work of spinners, weavers, fullers, dyers, finishers, each 
of whom worked at a single process with specialised tools. 
The cutlery trade to-day is still largely in this condition. 
The forging, grinding, and putting together of the different 
parts are each the work of a specialised workman, though 
the " cutler," who puts together, performs not one but 
thirty or forty operations. Such subdivision of processes, 
in addition to increasing the efficiency of the worker at 
the specialised task, leads to improvements in tools, and 
ultimately to the invention and application of machinery. 
A trade in which the making of the article is the work of a 
number of workers, each speciahsed to a single process, 
is, in Marx's words, " a productive mechanism the parts 
of which are human beings." 

II 

Machinery 

|i productive mechanism the parts of which are human 
beinffs " tends inevitably to give way to a productive 



26 ECONOMICS chap. 

nieclianism the parts of which shall be inanimate machines. 
The use of machinery is a result of the division of labour. 
Once the processes of any manufacture have been split 
up into operations so simple that they can be called 
" mechanical," the manufacture is ready to be taken over 
by a machine. A machine is more reHable and efficient 
than the most accurate of human workers ; a human being, 
however restricted in the scope of his activities, is not a 
machine, he is liable to fatigue and inattention, and cannot 
give the unceasing regularity and uniformity of a steel 
tool mechanically actuated. The handing over of a 
process to machinery may be delayed by the existence of 
cheap labour, but ultimately the machine is bound to 
win. 

The application of machinery to industry, itself the out- 
come of division of labour, leads to the further specialisation 
of human workers. A machine is a specialised tool which 
cannot be taught to do anything for which it was not 
originally intended ; it is confined to a single process or 
to a narrow range of processes, and the human worker who 
tends it becomes just as specialised himself. We get, 
therefore, a new series of crafts, arising from the need of 
special skill to tend special machines. This is not, however, 
a permanent condition of things ; so far as the increasing 
perfection of machinery makes special human skill un- 
necessary, it tends to have the opposite efiect on the worker ; 
so far as the machine takes over all the speciaKsed work, 
it tends to make the worker an imspecialised tender of 
machines in general. The increasing use of automatic 
machine-tools for instance in some branches of engineering 
tends to make unnecessary the speciaUsed skill of turner, 
driller, planer, slotter, etc., and to require only the general 
skill of the man who " sets up " a machine. 



II THE DIVISION OF LABOUR 27 

In otiier and more important ways the application of 
macMnery to industry promotes the division of labour. 
It makes the process of any manufacture more " round- 
about " than it was before. The use of machinery requires 
the specialisation of a certain proportion of the workers 
engaged in any industry to the making of the machines. 
That in its turn requires the specialisation of other workers 
to the making of tools for making machines, and to the 
extraction and working of iron and the other raw materials 
from which these are made. The manufacture of cloth for 
instance no longer employs only the shepherd and shearer, 
the spinner, weaver and finisher ; it requires also, as we 
have seen, many classes of engineers to make the carding, 
combing, and spinning machinery, the looms, etc. It 
requires also the specialisation of more workers to make 
the power-plant, to feed it and tend it. It creates in fact 
the great trades of machine-making, engineering, and coal- 
getting which lie at the foundation of all big manufactures 
to-day. Hence the social co-operation, which results from 
the speciahsation of individuals, has become infinitely more 
complex and far-reaching. 

Non-human power, such as steam, is of use in industry 
when the final processes of manufacture are still dependent 
on the speciahsed skill of manual workers ; it becomes 
infinitely more important when these processes are executed 
by machines. The machine requires room to house it and 
power to drive it, and one room and one power-plant will 
serve many machines. The application of power to industry 
leads to the collection of many machines in one building 
and the employment of human workers in regiments. The 
use of machinery is limited in its scope without non-human 
power ; and on the other hand, the construction of large 
power-plants is possible only by the use of machinery. 



28 ECONOMICS chap. 

Once power and machinery have been invented, the scope 
of industry is enormously widened. The specialised worker 
ceases to manufacture directly ; he tends and controls 
machines and engines which manufacture for him. Labour, 
whether it becomes more or less specialised, becomes in- 
creasingly co-operative in character ; in Marx's words, 
" the co-operative character of the labour process is . . . 
a technical necessity dictated by the instrument of labour 
itself." 

And this new co-operation of machine-makers with 
other workers, of non-human power with human labour, 
makes enterprises possible, which were inconceivable so 
long as human workers had not specialised some of their 
labour to producing this power. No collection of human 
beings could exert directly the concentrated force of a 
steam-hammer ; you could not, as Professor Meredith 
remarks, have a railway on a domestic system. Power 
increases the speed and output of machinery and labour 
to such an extent that the individual worker cannot main- 
tain himself in industry without its aid. The relation of 
man to machine is reversed ; before the application of 
power the former is principal and the latter assistant, 
after the application of power the machine is principal and 
the man assistant. The ownership of the instruments of 
production becomes vastly more important, and production 
by individuals and little groups gives place to production 
by regiments of workers in factories. The application of 
non-human power to machinery, then, is the revolution in 
any industry, and the simultaneous application to several 
important industries is the Industrial Revolution. 



II THE DIVISION OF LABOUK 29 

III 

The Localisation of Industries 

Following our clue specialisation, we shall understand 
another feature of modern industry, the concentration of 
industries in particular localities. In modern industry 
labour and machines are specialised wherever there is a 
sufficient volume of trade to keep a specialist constantly 
at work ; the main processes in the manufacture of the 
chief products of industry are all of them carried on by 
speciahsed machines tended by specialised labour. Now 
the simplest way for a firm to make sure that there 
will be sufficient volume of trade to enable it to adopt 
these methods of specialisation is to establish its works in 
a district where there are other firms engaged in the 
same trade. 

The influences which have brought a particular in- 
dustry to a particular district can be discovered only by 
studying its history. But three influences are usually 
predominant. First, cheap power, in the form of coal or 
water ; and this is the most important to-day. The great 
industrial centres of the world are its coal-fields. Any 
technical invention which ofiered a cheaper source of power 
than coal — such, for example, as the use of the tides — 
would tend to re-arrange the distribution of industry ; in 
another century industry may be concentrated on the 
creeks of St. George's Channel, while people go for quiet 
and recuperation to Wolverhampton and the Potteries. 
At present, however, so great is the concentration of 
industry and population on the coal-fields that heavy raw 
materials, such as clay for the Staffordshire potteries and 
iron ore for the South Wales iron industry, are shipped to 



30 ECONOMICS chap. 

tlie coal-fields, not the coal to them. Cheap labour has an 
attraction for industry similar to cheap power ; the in- 
dustries of East London are many of them based on the 
cheap labour of the wives and children of dockers. The 
second great influence is accessibility to raw materials. 
The manufacture of steel is strongly localised on those 
coal-fields which have ore-deposits adjacent, or, being on 
the coast, can import foreign ores. The flour-milling 
industry, which was formerly distributed as widely as the 
growing of corn, tends in England to concentrate at the 
great ports, because England has come to depend on 
imported corn. The third great influence is accessibility 
to markets. The last two influences were much more 
important before the Industrial Revolution than they 
are now that transport has become so cheap ; the im- 
portance of the first dates, of course, from the Industrial 
Revolution. 

Whatever the influences, however, which bring an 
industry to a district, the chief advantages of localised 
industry are all due to the opportunities for greater special- 
isation which concentration afiords. Where many firms 
engaged in the same industry are grouped together, the 
worker has a better market for his speciahsed skill and is 
encouraged to specialise still further. The employer has 
less difficulty in finding the kind of labour he wants. The 
industry can command a large number of special services 
which no single firm could afford, and no scattered industry 
could maintain. Among the most important of such services 
is the specialised market. Liverpool and Manchester 
provide the cotton-spinner and manufacturer with faciUties 
for getting their raw materials and disposing of their 
finished products which they could find nowhere else, and 
these facilities can be supplied only because the cotton 



II THE DIVISION OF LABOUR 31 

industry is so strongly localised. Bradford is the centre 
of the woollen and worsted industry, and nine-tenths of 
the wool that enters the country is bought and sold on the 
Bradford Exchange. The goods of the locality advertise 
one another, making access to new markets easy and giving 
an advantage in old markets ; merchants and other dis- 
tributing facilities grow up ; " to be a Huddersfield worsted 
manufacturer or a Galashiels or Hawick tweed manu- 
facturer is enough in itself to raise the individual out of 
the ruck of some sort of competition and to justify the 
asking of a certain price." Special transport facilities and 
the provision of commercial intelligence can be arranged 
for a locahsed industry. Scientists, lawyers, accountants 
find it worth their while to specialise in the problems 
peculiar to the local industry. Insurance can be effected 
cheaper. Probably the use of credit can be obtained cheaper 
where risks and conditions are so well known as they 
are in a modern specialised locality. 

An important type of specialised services is the growth 
of subsidiary industries, supplying the staple industry with 
its machinery and incidental requirements of manufacture, 
and utilising its by-products. The making of machinery 
is less locahsed than other great industries, because the 
requirements of a modern localised industry are so special 
that they can best be met by a firm on the spot. The 
textile districts are the seat also of the dyeing and finishing 
trades, speciaHsed to suit the particular material manu- 
factured in the district ; and these in their turn attract 
certain chemical and drysalting trades. The complete 
utihsation of by-products is one of the most important 
economies of modern industry, and is possible only where a 
locahsed industry makes a large bulk available without 
transport charges. Science can find an industrial use for 



32 ECONOMICS chap. 

most things, provided that they can be had in quantities 
and cheap. 

While the tendency to speciaHsation is universal in the 
great industries, the relation of the specialised process to 
the firm or business unit varies. The specialisation may 
take place within the firm or within the trade ; i.e. processes 
may be carried out by specialised departments in the fijcm^ 
or by specialised firms in the trade. During the greater 
part of the nineteenth century the tendency was for 
individual firms to devote themselves more and more 
exclusively to a single process or a small group of related 
processes. To-day in many trades the tendency is in the 
opposite direction, namely, to unify under one management 
all the processes in the manufacture of a given product. 
The opposing tendencies may be seen most clearly by 
contrasting the heavy steel industry with the leading 
textile industries. In the former, till the middle of the 
nineteenth century, the different processes of the manu- 
facture of steel, the getting and blasting of the ore, the 
manufacture of steel, the working of the steel, and the 
construction of ships, bridges, and other heavy steel goods, 
were carried on chiefly by separate firms. To-day the rule 
is for all processes to be carried on by the same manage- 
ment. In the Yorkshire worsted industry, on the other 
hand, the different processes, combing, spinning, weaving, 
dyeing, and finishing, are usually undertaken by separate 
firms ; many firms deal with one special kind of wool or 
yarn only, and it is the rare exception for a single firm to 
carry the wool through all the processes of manufaeture. 
The specialisation of labour and processes is just as detailed 
in the heavy steel industry as in the textile industries, but 
the business unit is different. To some extent the differ- 
ence is due to technical economies ; in the steel industry, 



n THE DIVISION OF LABOUR 33 

where the whole manufacture is under one management, 
the steel can be passed forward from process to process 
without reheating. Another reason may be the difference 
in the size of a unit of product. In the heavy steel industry 
the unit is immense — a bridge or an ocean liner — and the 
contributing processes of manufacture are very numerous 
and varied ; hence centrahsed management is an economy. 
In the textile trades the unit of product is small — the 
piece — the processes of manufacture comparatively few 
and simple, and success in management dependent chiefly 
on securing a large and steady output of uniform quality. 



IV 

Large-scale Production, and the Limits of Specialisation 

An important result of the specialisation of labour and 
the use of power-machines has been the growth of large- 
scale enterprise. How far does this tendency go ? The 
terms large-scale and smaU-scale enterprise are obviously 
relative to the industry, and the chief influence in fixing 
the average size of the business is the technical methods of 
the trade. Small-scale coal-mining is still carried on, but 
it is unimportant ; while steel shipbuilding can be carried 
on only by a large concern. Certain general aspects of 
organisation, however, can be considered without immediate 
reference to technical considerations. 

On the whole, there is a steady tendency towards 
enterprise on a large scale. The advantages of large- 
scale enterprise are very like the advantages of localisa- 
tion of industry, since they consist chiefly in the greater 
specialisation of implements and workers which a large 
output permits. A large works can employ highly 

D 



34 ECONOMICS chap. 

specialised workers of all grades, and keep them fully 
employed on their special work ; it can buy the best skill, 
and get good value for a good wage, while a small firm 
that employs a highly speciaUsed worker will have to use 
him part of hia time for other purposes, for which a less 
paid worker would have done as well. The large firm 
can do the same with machines ; it can build an automatic 
machine for a single detail of a single process, because its 
large output ensures that this detail will recur so frequently 
as to keep the machine constantly at work. It can afiord 
resources which a small firm has not enough work to make 
worth while. A big engineering shop with its electric crane 
will move a casting in a tenth of the time taken in a small 
shop without that convenience. A big works can have its 
own railway-sidings and wharfs, its repair shops to save 
time and prevent dislocation in case of a breakdown. A 
Eockefeller dealing with oil in bulk could construct a 
system of pipe-fines for distributing it which was very 
expensive, but, once it was constructed, far more eco- 
nomical than any other means. The big concern can save 
sometimes by buying its material in bulk. It should 
always save in its selling organisation by employing fewer 
travellers and advertising less : its goods advertise one 
another. 

The advantages of large-scale production are so great 
that we might expect the small firm to be driven out of 
industry. But the small firm refuses to be driven out ; 
if the reader doubts this, let him consult a local trade 
directory and count the number of small businesses in it. 
The small firm has advantages of its own to set against 
the obvious economies of a large output. We nmst re- 
member that small and large firms are usually competing 
for a growing volume of trade, not for a fixed amoimt ; 



n THE DIVISION OF LABOUR 35 

so that the gains of the large concern need, not necessarily 
be at the expense of the small concern. But there are 
other reasons, especially the difficulties connected with the 
organisation of a big works. "With every increase in the 
size of a concern, there is a more than proportionate increase 
in the difficulty of management and organisation. " Just 
as in an army there are many who can fill the position of 
captain, few who can fill that of colonel, and almost none 
who are competent to be generals in command — so in 
industrial enterprise there are many men who can manage 
a thousand dollars, few who can manage a milHon, and next 
to none who can manage fifty millions." ^ Hence there 
is usually more waste in the big than in the small concern ; 
especially is this the case when the firms contrasted are 
a large joint-stock company managed by salaried officials 
and a small private business managed by the owner, who 
bears any loss due to waste. 

A particular form of waste and a weakness of all big 
concerns is the tendency to routine. The detailed special- 
isation, the need for checks and records, involve routine 
— the routine we call " red tape " in the case of 
Government Departments — and routine kills initiative 
and adaptability. The big concern can usually produce 
only standard fines. It cannot adapt its organisation so 
quickly as the smaller firms to the changing wants and 
whims of the customer. It can give the customer the 
kind of thing he wants much more cheaply than the small 
firm ; it can seldom give him exactly the thing he wants, 
and the customer will often pay out of all proportion for 
the sfight additional satisfaction of getting the exact 
thing. 

^ A. T. Hadley, quoted by Macgregor, Industrial Combination, 
p. 37. 



36 ECONOMICS chap. 

In some important industries there are teclmical obstacles 
to large-scale enterprise. Wherever the material worked 
is not uniform in quality, or cannot be graded and treated 
in bulk, then the large-scale method of specialised processes 
and large output will not apply. In agriculture the opposi- 
tion appears clearly. Where population is sparse and land 
is cheap, grain farming with agricultural machinery or 
stock raising on a large scale is economical. In more 
crowded regions it pays better to utilise the slightly varying 
qualities of every acre — by fruit, vegetable, or dairy farming 
— and the necessary care and detailed attention will be best 
given by the small farmer, especially the small proprietor. 

Again, specialisation within the trade puts within the 
reach of the small firm facilities which, but for the localisa- 
tion of industries, would be within the reach of large firms 
only. The full utilisation of bye-products, the adaptation 
of means of transport to the needs of the staple trade, 
insurance and credit agencies, special markets, the services 
of experts and subsidiary industries, all help the average- 
sized concern to hold its own in the market against the giant 
concern. The development of large-scale production in a 
subsidiary industry or a section of an industry may be a 
help to small-scale enterprise in another part of the industry; 
the small joiner can get mouldings from the large saw-mill, 
the small cycle-builder parts from the factory which makes 
parts. In every trade, however, there seems to be a point 
beyond which any increase in the size of the concern brings 
no new economies, or rather beyond which any new 
economies are neutralised by the increased difficulty in the 
work of management. This limit is constantly receding as 
the work of management is reduced to routine or science ; 
but the limit is always there in the limited capacity of the 
average business man. And such statistics as are available, 



II THE DIVISION OF LABOUR 37 

especially those of the United States, ^ the country in which 
the tendency to concentration is strongest, show that the 
number of separate businesses is increasing more rapidly 
than the population. 

The small firm holds its own ; the average size of firms 
increases, but the number of firms also increases. The 
advantage of the big firm is that it can carry specialisation 
further ; the strength of the small firm lies in the limits 
of specialisation. How far can specialisation be carried ? 
We may go again to Adam Smith for our answer : " The 
division of labour is limited by the extent of the market." 
Unless there is a large market, which implies a large, steady, 
and uniform demand, specialisation does not pay. It does 
not pay to specialise a man or a machine, unless there is 
sufiicient work to keep them constantly employed on their 
special work. Specialisation is most economical when 
applied to a manufacture that can be standardised, and an 
article or process cannot be standardised unless there is a 
large trade. 

Now there are many articles and services for which 
the demand is not large, steady, and uniform ; there 
are many processes of manufacture which cannot be 
standardised. Here is the field of the small firm. When a 
single specialised craftsman performed all the processes of 
a manufacture, he not infrequently, as a part of his craft, 
made and repaired his own tools. The " tools " of modern 
industry are machines, and the making of them is a special- 

^ NumTjer of factories, excluding hand p-nd neighbourhood 
industries : — 

1899 (recorded in 1900 Census) . . 207,514 

1904 ( „ „ 1905 „ ) . . 216,180 

1909 ( „ „ 1910 „ ) . . 268,491 
Including hand and neighbourhood industries : — 

1889 (recorded in 1890 Census) . . 355,405 

1899 ( „ „ 1900 „ ) . . 512,191 



38 ECONOMICS chap. 

ised industry with many branches ; the repairs, however, of 
modern industry cannot be so specialised. Consequently, 
there are many small businesses which are occupied wholly 
in repairs ; and though the system of constructing all 
machines of interchangeable parts makes the work of many 
of them unnecessary, there must always be a need for some 
" general " artisans and businesses capable of deahng with 
any repair. Similarly, the advantages of being on the spot 
and not too specialised will probably enable the single 
workman to keep a large share of the work of domestic 
repairs and retail shopkeeping. 

Technical difficulties in the way of standardising pro- 
cesses still offer obstacles to large-scale production, as in all 
kinds of intensive agriculture. Cutlery and other light 
metal trades, though using more and more machinery, will 
long retain a place for the " little master." Thirty-eight 
separate operations are needed to put together the parts 
of a cheap pocket-knife, and such work does not ofier much 
scope to the automatic machine. So far as power is needed, 
there was a force driving the " httle master " into the 
factory ; but that force works now rather in the opposite 
direction, for the little master can obtain a supply of 
power in his own workshop by employing electricity. When 
an industry is new and its methods and processes are still 
experimental, the adaptability of the small firm is a greater 
advantage than the resources of the large fixm, and the 
small firm usually plays the part of pioneer. The biggest 
firms, in industries in which large and small firms are both 
found, are often firms which began in a small way and 
seized their chance when the industry was new, or when 
some invention or new market gave the industry a new 
start. 

In some industries, though the processes could be 



II THE DIVISION OF LABOUR 39 

standardised, the demand for an article is so limited that 
it would be absurd and wasteful to employ the resources 
of modern machinery and industrial organisation. The 
weaving of short patterns and ranges in the textile trades 
is largely done on hand-looms for this reason, and certain 
expensive Paris fabrics, where the order for a pattern may 
not exceed a dozen yards, are still manufactured by " little 
master " weavers working for merchants. These workers 
are in the same economic position — though they possess 
a much higher economic and social status — as many of 
the " sweated " workers. Among " sweated " workers the 
division of processes has usually been carried far enough to 
make the work of each individual simple and easy, but the 
natural evolution from that simplified manual work to the 
use of power-machines has not taken place because the 
labour can be got cheaper than the machine. Hence the 
domestic hand-workers in such trades as the East London 
tailoring, shirt-making, and box-making trades are com- 
peting with power-machines in the factory trades of Leeds 
and other centres, and can sustain the competition only 
by accepting wages too low to " keep " them in any real 
sense. 

Wherever individual requirements have to be met, the 
factory -made article is out of place. Clothes and boots 
are made in factories ; but if we want clothes or boots that 
fit exactly, and not merely approximately, we go to the 
" bespoke" tailor or boot-maker, who does not carry special- 
isation far. Individuality is the essence of art ; to be 
beautiful it would seem that a thing must bear the impress 
of its maker's personality. There is little room then for 
specialisation in the making of beautiful things. If we 
want the material apparatus of life to be beautiful, we must 
be content with less of it ; we must choose between a great 



40 ECONOMICS chap, 

many ugly and ordinary tMngs and a few beautiful and 
unique things. 

Adam Smith's principle " that the division of labour is 
limited by the extent of the market," is illuminating in 
another respect. The most important influence in deter- 
mining the extent of the market is the state of the means 
of transport. Every improvement in the means of trans- 
port makes exchanges economical which before were not 
economical. It enables the district which can produce an 
article cheapest to supply other districts more cheaply than 
they can make for themselves, that is to extend its market ; 
therefore, Adam Smith says, " good roads, canals, and navi- 
gable rivers, by diminishing the expense of carriage . . . are 
. . . the greatest of all improvements." Cheap transport 
encourages the full utilisation of special local advantages 
such as chmate, soil, traditional skill, established organisa- 
tion ; the production of goods where they can be pro- 
duced cheapest ; the progressive localisation of industries ; 
and the use of the resources of each district for the benefit 
of all districts. Trade began in luxuries ; with improve- 
ments in roads and the art of navigation, it extended to 
comforts ; in the nineteenth century, with the application 
of steam-power to transport, it extended to the necessities 
of life. Transport is now so cheap that in advanced in- 
dustrial countries districts are Hke individuals, specialised 
in production and dependent on exchange for the satisfac- 
tion of their most important wants. Because the localisa- 
tion of industries, with all its economies in production is 
dependent on cheap and efficient transport, the transport 
industries are, with the steel and coal industries and the 
credit system, at the foundation of the modern industrial 
organisation. 



THE DIVISION OF LABOUR 41 



The Evils of Specialisation 

The benefits of the division of labour lie in the increased 
power it gives man to produce wealth of all kinds. This 
increase is incalculable ; witliout it life would be like the 
hfe of Hobbes's primitive man, " solitary, poore, nasty, 
brutish and short." If any reader doubts the benefits, let 
him make a list of the things he uses and consumes in the 
course of a single day, and then estimate the time it would 
take tdm to produce these by his own unaided labour ; such 
an experiment will do more than any amount of reading to 
convince him. But these benefits are accompanied for 
the worker by serious evils, and the benefits have rather 
obscured the evils and prevented due efforts to remove 
them. One reason for this neglect may be that modern 
industrial methods have incidentally counteracted some of 
these evils. The great improvement in the material con- 
ditions of the worker's life, which has resulted from the 
greater productivity of modern industry, has given the 
industrial worker opportunities of self-culture which have 
neutralised some of the evils of specialisation. He is better 
clothed, better fed, better housed, and he lives a fuller life 
outside his work than he did in the days when the work 
itself was less narrowly specialised and more educational. 
Similarly, the concentration of the industrial population in 
towns, in spite of its peculiar evils, has stimulated intellectual 
hfe and, with increased leisure and income, done much to 
counteract the deadening effects of monotonous employ- 
ment. The Lancashire cotton operative is occupied with a 
far narrower range of operations than the farm labourer ; 
his material environment is far less varied, and his work 



42 ECONOMICS chap. 

far less interesting, yet his intellectual life is far more 
vigorous ; the general intellectual keenness of some Lanca- 
shire towns might put some universities to shame. 

But the advantages, direct and indirect, of the division 
of labour are no reason for ignoring the evils, if any con- 
sideration of these will tend to reduce them. We shall refer 
to them again in Chapter XXIV., but some considera- 
tion of them will not be wasted here, since we shall have 
to refer to the division of labour again and again in the 
intervening chapters. The first of these evils is the inevi- 
table danger that the workman will be treated simply as 
a means and not as an end. Dr. Ure, and other early 
advocates of the Factory System, did habitually write as 
if man was intended for production; not production for 
man ; they justify Marx's statement :; " In its machinery 
system Modern Industry has a productive organism that 
is purely objective, in which the labourer becomes a mere 
appendage to an already existing material condition of 
production." The earlier English factory owners were 
guilty of the systematic exploitation of child - labour, 
Machines were adapted, and the processes of manual labour 
simplified, to suit the children's powers, and their labour 
was used with entire disregard to their subsequent life. 
The half-timer of to-day, the dofiers in the worsted factory 
who acquire a skill worth 3s. 6d. a week and learn 
nothing more, the cotton-piecers who by no possibility can 
all of them become spinners ; the youths who work light 
automatics in machine shops and earn a good wage for a 
youth, without having the chance of fitting themselves for 
earning a good wage for a man ; the whole crowd of " Blind 
Alley " occupations which the Poor Law Commission in 
1909, and Karl Marx in 1867, showed to be an integral part 
of the modern industrial system, are only the most striking 



n THE DIVISION OF LABOUR 43 

example of this use of tuman beings as " means *' of pro- 
duction without reference to their right to consideration 
as " ends," The latter instance has attracted attention 
because the industrial use of children and adolescents 
often makes them industrially useless when they become 
adults. But the detailed specialisation of labourers must 
always hamper the all-round development of the faculties, 
which was the Pagan ideal of manhood and is not incon- 
sistent with the Christian ideal. Specialisation of labour 
and monotony of work make for economic efficiency, but 
are not therefore wholly good ; by themselves they tend 
to produce lop-sided development in the man ; and the 
social system which accepts the increase of wealth due to 
the monotony of work, without devoting some of it to 
counteracting the effects of that monotony outside work, is 
forgetting the end for which wealth is produced. 

This tendency of the division of labour to degrade or 
hamper the development of large masses of workers is not 
noticed, because the increased wealth due to it neutralises 
many of its ill effects. But the tendency is there, and, if 
anything, is increasing in strength. The actual processes 
in which the detail labourers are engaged are perhaps 
calling for a higher type of machine-tender, and the ex- 
ploitation of child-labour is diminishing ; but the manual 
labourer is getting less if anjrthing of the organising work 
in industry, the work of direction, which requires initiative 
and develops character. The specialisation of the work of 
direction, of organisation, of initiative in the hands of a 
small proportion of the whole number of people " engaged " 
in industry, is perhaps the greatest evil of the modern 
industrial organisation. It removes from the work of the 
great majority of people the educational element, the 
element that develops the highest faculties and character. 



44 ECONOMICS chap. 

The mediaeval craftsman, like the working farmer to-day, 
was constantly making choice between alternatives and 
exercising his judgment and initiative ; and exercise develops 
will and judgment. Not only were the processes of manu- 
facture not reduced to routine, but each man had the 
conduct of the business side of his work himself. He was 
his own master, self -controlled ; he dealt directly with the 
market, and though the market was a httle local market, 
a simple thing compared with the market of to-day, it did 
take a man outside his workshop and gave him some prac- 
tice in the difficult art of adjusting social relations. 

The great mass of workers to-day are not self -controlled; 
they are cogs in a machine controlled by others, and their 
efficiency depends less on their initiative and adaptability 
than on mechanical regularity of work. They have no 
part in the organisation of the workshop ; they have no 
part in the organisation of trades which is done in the 
market. Their work is routine — requiring often a very 
high degree of speciahsed skill, but still routine ; and 
routine is not educational. It kills initiative and stupefies 
character. The grading of work, the possibility of keeping 
your ablest men constantly occupied on the most difficult 
work, which is always pointed out as one of the chief 
economies of the division of labour, tends to be reahsed. 
The great organiser has concentrated in his charge all the 
work of organisation and direction which an industrial unit, 
including hundreds of workers, requires ; and if he has the 
work the others cannot have it. He does it far better than 
smaller men would do it ; but the fact that he does it and 
they do not makes him bigger still and them smaller still. 
What originality they are capable of is never developed, 
while his organising faculties are developed to their highest 
pitch. The work of organisation, direction, initiative, tends 



II THE DIVISION OF LABOUR 45 

to be specialised, like any process of material manu- 
facture. The economic result is more eflB.cient organisation 
and direction, and an increasing rate of technical progress ; 
the social result is that the mass of adults have their chief 
educational element taken out of their work ; and since their 
work occupies the greater part of their working lives, and 
has the first claim on their faculties, the loss is irreparable. 
Probably this concentration of responsible work in the 
hands of a small class, the great majority of workers being 
speciaHsed to automatic, non-responsible work, is the chief 
explanation of the most remarkable social phenomenon 
of the time. In some Western countries with democratic 
franchises one-tenth of the people own nine-tenths of the 
wealth. A considerable proportion of the voters are con- 
stantly on the verge of destitution, while a small minority 
flaunt in their faces the most extravagant luxury. How is 
it that the populace does not use its poKtical power to 
remove such inequalities ? Wliat is it prevents the social 
revolution ? It is not a scientific understanding of the 
reasons of these inequalities, or any doubt as to the possi- 
bihties of reorganising industry without them, for no 
study is so neglected in Great Britain as the scientific study 
of economic organisation. The explanation is largely 
habit, the inertia of uneducated masses, the fatalism that 
is almost inevitable after ten hours a day, five and a half 
days a week, and fifty weeks a year of monotonous toil in a 
factory. But another explanation is that the people who 
sufier most under the present industrial system have the 
habit of initiative rigorously groimd out of them by the 
system. If they have ideas of something better they have 
no experience of putting ideas into effect. They are 
revolutionary and Utopian when what is wanted is the 
practical experience of the business man. They are so in 



46 ECONOMICS chap. 

the habit of being told what to do that they do nothing 
when they have only themselves to tell them to do it. Of 
course there are individuals who retain their initiative and 
capacity for direction in spite of the mechanical nature of 
their work, but they — even if their capacity does not hft 
them out of their class — are helpless so long as the mass of 
their fellows succumb to the mechanical nature of their 
work. In Marx's words, " the separation of the intellectual 
powers of production from the manual labour, and the 
conversion of these powers into the might of capital over 
labour, is . . . finally completed by modern industry 
erected on the foundation of machinery." 

The individual labourer suffers in another way. By 
being forced to speciaHse, he is forced to incur the risks of 
specialisation. The highly speciaHsed workman is in the 
same position as the capitalist who has invested his capital 
in highly specialised machinery. His skill has only a 
limited field of employment, and loses its value outside 
that field. Hence he may be forced to accept terms which 
are below the market price for that standard of energy 
and knowledge, the only alternative being to give up his 
special skill and seek employment in another trade. The 
fact that there was a dearth of coal-hewers would not assist 
the artisan in an overcrowded trade to protect his standard 
of life. Further, the artisan with a highly specialised skill 
has a commodity to sell which may have a monopoly value 
one year and have lost its value the next owing to some 
invention. The owner of machinery provides against a 
similar event by writing off so much of the value of his 
machinery annually ; the owner of skill should perhaps do 
the same, but the wages are rarely big enough to encourage 
such rigorous account-keeping ; and the possibihty which 
technical science continually ofiers the employer of dis- 



n THE DIVISION OF LABOUR 47 

pensing witli certain classes of skill by introducing new 
processes seriously weakens tlie bargaining position of the 
workman and increases his dependence on the employer. 
The egregious Dr. Ure's description of the self-acting mule, 
" a creation destined to restore order among the industrious 
classes," and the inference he draws, " when capital enlists 
science into her service, the refractory hand of labour will 
always be taught docility," are very significant. 

The extreme specialisation of modern industry is not 
without its disadvantages from the point of view of pro- 
ductivity. While it increases the efficiency of the labourer 
for particular tasks, it limits his scope, lessening his adapta- 
bility and capacity for undertaking novel work. And the 
technique of industry changes rapidly. " We do not to-day 
want men who are ' all round ' at building marine-engines 
— ^we do need men who are ' all round ' mechanical engineers 
— men who can apply the principles of their craft to any 
form of machinery that may be called for," Sir Christopher 
Furniss told the Poor Law Commission. " If [the boy's] 
training is sacrificed to the demand for a very hmited and 
highly specialised skill in the management of one kind of 
machine or in one operation, the factory may benefit at 
the moment, but will suffer later on in having too few 
thoroughly trained men to draw upon when conditions 
change, as they must do in any progressive industry " 
(Professor Barr). Engineering employers who complain 
that they cannot get men capable of anything but a single 
job have themselves to blame. The speciaHsation of 
labour that pays the individual employer may be an 
economy in production for which society has to pay in the 
long run. The rate at which technique improves is limited 
by the capacity of labour to work the new methods. 

This raises the question whether the use of machinery 



48 ECONOMICS cil^p. u 

may not make special skill unnecessary and ultimately 
restrict the division of labour. No generalisation is possible. 
Machinery has undoubtedly superseded and is superseding 
" craftsmanship " in all staple manufactures. That is the 
first effect of mechanical invention ; the machine takes 
over the work formerly performed by the specialised 
manual skill of the labourer and makes the labourer a 
machine-feeder. But there is another effect. When the 
machine-feeder's work is purely mechanical the machine 
can take it also over ; and the labourer's work, instead 
of being the mechanical " feeding," becomes the more 
complicated task of " setting up " the machine. Where 
women and yoimg persons are emploj^ed power machinery 
has reduced the demand for skill ; but in the greater 
industries employing adult male labour, while a lower 
grade of manual skill is required, a higher level of general 
intelligence is required. Machines become more intricate 
and delicate, and alter more rapidly ; their charge cannot 
be entrusted to men who have not both manual dexterity 
of a varied kind and an intelligent comprehension of the 
principle of the machine. Progressive employers who are 
constantly experimenting with new processes and methods 
may take trouble to train versatile and intelhgent work- 
men. But a large output can usually be secured on con- 
servative lines by the extreme specialisation of labour ; 
and that specialisation makes against versatility and in- 
telligence. To secure the plentiful supply of versatile and 
intelligent workmen that is essential if technical progress 
is not to be hampered, a system of technical education is 
needed for the rank and file as well as for the future leaders 
of industry which shall not be mere instruction in trades, 
but a liberal education in the sciences imderlying technology, 
and this the best technical schools are trying to give. 



CHAPTER III 



THE ORGANISATION OP PRODUCTION 



The Co-ordiyiation of Sjjecialists 

We liave seen that specialisation is tlie principle on whiclx 
the whole modern organisation of industry is based ; let 
us see where it has led us. The man who wants a shirt no 
longer makes cloth and from the cloth makes a shirt. He 
buys the shirt, and the shirt is made by the combined 
labour of some hundreds of specialised VN^orkers scattered 
all over the world. Every worker who takes part in the 
making of the shirt is specialised ; by himself he can do 
little or nothing, his labour is useful only when combined 
with the labour of other men equally specialised and there- 
fore by themselves equally useless. Every machine that is 
used is of service only because it is co-operating with the 
right kind of labour and with other machines. Every firm 
is speciahsed ; it makes nothing by itself, merely contribut- 
ing its part to the whole process of making the shirt. What 
is called in ordinary conversation " the manufacture of 
shirts " is only the completion of a long process which 
began when the sheep was sheared that supplied the wool, 
or shall we say when the sheep was bred ? Every industry 

49 B 



50 ECONOMICS chap. 

is specialised, and many industries contribute to the making 
of one shirt ; it is only by the co-operation of the sheep- 
farming, spinning, weaving, finishing, clothing, machinery, 
coal, transport, and many other trades that the modern 
shirt manages to get itself made. Thus specialisation has 
brought us to a condition in which labourers are helpless 
by themselves, machines are useless by themselves, firms 
make only a fraction of an article, and industries can do 
their work only by co-operating with other industries. 
How is all this co-operation brought about ? How are all 
the specialists linked up into an organisation that can turn 
out shirts at ten shillings each ? 

The specialists themselves are seldom conscious of this 
co-operation ; they do not do their work because others 
are dependent on it, but because they are paid to do it. 
Their combination is at first sight not the combination of 
a good football team, but the combination of a mob, or 
of the separate particles of water that combine under the 
compulsion of external force to form a stream. Nor is this 
co-operation organised by any central authority. Such an 
arrangement might have been possible in a City-State or an 
isolated kingdom, and the State at some periods in the past 
has attempted to control the direction of productive effort. 
But even in the time of the Gilds and under the Mercantile 
System, the movements and organisation of industry were 
the result of spontaneous arrangements between individuals, 
regulated perhaps, but not dictated by the State. And 
to-day the industry of different countries is so intimately 
bound together in world-markets that there is no central 
authority far-reaching enough in its scope to undertake 
the direction and control of such extensive co-operation. 

How then is this co-operation secured ? It is secured by 
a further application of the principle of specialisation itself, 



m THE OEGANISATION OF PRODUCTION 51 

by the existence of a class whose work it is to organise this 
co-operation. Side by side with the growth of speciaUsa- 
tion in the processes of production, there has grown up a 
class of men whose business it is to link these speciaUsts 
together and to make a working organisation of them. 
These organisers of modern industry correspond roughly 
with the class we in England call " business men." The 
specialised labourers are collected and supplied with the 
necessary tools, machines, and material by one set of 
organisers ; to supply exactly the right kind and amount 
of labour with exactly the right kinds and amount of 
capital, and to keep them working steadily and harmoni- 
ously without waste of material, time, or energy, is a work 
requiring special knowledge and technical skill, and society 
relies on its " captains of industry " to supply this know- 
ledge and skill. What the head of the firm does along with 
other work, the foreman, the shop-manager, works-manager, 
general manager do as their special work ; they organise 
industry, they decide what shall be the exact division of 
labour, they decide in what form of tools and machines the 
capital of society shall be appHed to industry — ^important 
work, even though the majority of them are content to 
copy their neighbours and follow a traditional routine. 



II 

The Functions of the " Middlonan " 

But what of the specialised firm and the specialised 
trade ? The division of labour has created gulfs not only 
between worker and worker, but between firm and firm and 
trade and trade. Who organises firms and trades into the 
great productive mechanism that delivered to us our ten- 



52 ECONOMICS chap. 

shilling shirt made of Australian wool and American cotton 
with Keighley machinery in a Eochdale mill ? This work 
is done chiefly by the head of the firm again. In a large 
firm parts of it will be delegated to salaried servants, but 
for the general supervision of it the head of the firm is 
responsible. He buys the raw material, thus bridging the 
gulf which the division of labour has created between, say, 
the firms that weave flannel and the firms that spin yarn 
or import wool. He is responsible for the mill's equipment, 
thus bridging that other gulf between the firms that make 
machinery and the firms that use it. But there is another 
class of organisers who do this work of linking together 
specialised firms and industries — the merchant or middle- 
man class. In the Yorkshire worsted industry the manufac- 
turer usually buys his yarn direct from the spinner ; but 
half the worsted yarn produced in Yorkshire is woven 
abroad, and the foreign manufacturers do not buy direct 
I from the spinner, they buy from yarn merchants. Between 
I every two stages in the productive process of any great 
' manufacture will be found the merchant or middleman, 
acting as a bridge over the gulf : cloth is bought by tailors 
from merchants who bought it from manufacturers ; yarn 
is bought by manufacturers from merchants who bought it 
from spinners ; wool tops are bought by spinners from 
merchants who bought the wool from other merchants, 
who bought it from the wool grower. It is by this middle- 
man class that co-operation between widely separated firms 
is organised ; without it our shirt would never have found 
its way half round the world and all through the West 
Riding from the sheep's back to ours. 

Popular opinion makes a sharp distinction between 
manufacturer and merchant, recognising the organising 
work of the former but not of the latter ; but the distinc- 



m THE ORGANISATION OF PRODUCTION 53 

tion does not correspond with any profound distinction of 
function. Tlie special functions of the two are rarely quite 
separated in actual business ; both are organisers, and in 
the real sense producers. The manufacturer buys raw 
materials, labour, capital equipment, and sells articles in a 
condition to be used either as raw material by another 
industry or as finished goods by the consumer. The mer- 
chant buys commodities in a condition to be used, and sells 
them where they are wanted ; without his collecting and 
distributing work the commodities would not be completely 
" produced," since they would not be in the places where 
they can be used. The division of labour between " manu- 
facturer " and " merchant " is convenient. The first 
business of the manufacturer is to manufacture, which he 
does by organising the co-operation of specialised workers, 
machines, and departments. But his business cannot be 
carried on unless there is a working connexion between it 
and the businesses which supply it with its equipment 
and raw material ; and its work is useless unless there is a 
working connexion with the trades or consumers who take 
its product. The estabhshment of this working connexion 
is the middleman's special work. It may be done by the 
manufacturer ; some of it always is ; but in most large 
trades there is a specialist, a merchant, to do it. 

Every trade has to buy from other trades, and has to sell 
its products. This buying and selling is inseparable from 
speciaHsed production. As the organising work ivithin the 
manufacture becomes more complicated, it tends to be done 
by a whole-time specialist. And similarly, as the connexions 
between trades become more complicated, the work of 
maintaining these connexions in a state of efficiency tends 
to become the exclusive work of a specialist. The two 
speciaHsts may be in the same firm ; the tendency is perhaps 



54 ECONOMICS chap. 

for both pieces of work to be entrusted to salaried officials 
of the same firm But the independent merchant — simply 
because he specialises in the needs of a whole trade and not 
in those of a single firm — can usually offer facihties which 
make it " pay " firms to deal with him. Thus he organises 
the co-operation of speciahsed firms and trades, in the same 
way as the works-manager organises the work of specialised 
workers and machines. This is obvious where the processes 
of manufacture are carried on largely on commission. The 
merchant in this case bears the same relation to the com- 
mission comber, spinner, manufacturer, and dyer and 
finisher, as the general manager of a steel works does to the 
furnace, foundry, rolling mills, machine shop and fitting 
shops, or as the manager of a weaving estabhshment does 
jto the warpers, winders, twisters and weavers, tuners, etc. 
I ^The merchant and the shopkeeper are called " middle- 
I men," however, not because they stand between firm and 
I firm, between trade and trade, and connect them, but 
I because they stand between " producer " and consumer. 
We often bear them a grudge for standing there, and are 
reluctant to recognise that they perform any useful function 
in return for the profits they obtain. Commerce and 
exchange are thought to be " unproductive," because 
things do not alter their form by being exchanged. Such 
a view is based on a misunderstanding of the process of 
production. The obvious question which it suggests is, 
Why does exchange go on ? Unless the parties to the 
exchange are both better off by it, why do both agree to it ? 
The objection ignores the obvious fact that the same thing 
may have difierent degrees of usefulness for different 
persons and at difierent places and at difierent times. 
Bananas are more useful to Englishmen than to West 
Indians because West Indians have more than they can 



Ill THE OUaANISATION OF PRODUCTION 55 

possibly digest, and any one who brings bananas from the 
West Indies to England is adding to the sum total of 
satisfaction in the world ; ice is more capable of satisfying 
wants in hot countries than in the arctic regions, in summer 
than in winter, and it does not make the sHghtest difference 
to the amount of satisfaction obtained from the use of ice 
in a hot summer whether the ice is imported from the 
arctic regions or saved in an ice cellar or manufactured. 

The middleman stands between producer and consumer, 
but not to obstruct ; if his profits are a toll, it is a toll 
levied not at a toll-bar on an otherwise open road, but a 
toll for the use of a very necessary bridge. It would be \ 
impossible for the consumer as a rule to order directly j| 
from the innumerable producers who co-operate in the | 
production of the simplest article ; it would be extremely '* 
difficult for the producers always to find the person who 
wants their product — even if any producer could per- 
form the impossible task of identifying on the finished 
article his particular contribution to its making. The 
middleman helps both ; for the producer he finds a market, 
for the consumer he finds out what he wants and gets it 
for Mm. Just as the suburban green-grocer calls round 
on his customers for orders, so the middleman finds out 
what things are wanted and where they are wanted, and 
collects them with a view to satisfying these wants. If the 
shopkeeper's customers had to go direct for everything they 
wanted they would never get half their wants satisfied ; so 
the shopkeeper collects and stocks all the kind of things 
that they want and lets them have them at the time and 
in the form and amounts in which they want them. Of 
course the middleman does not passively wait for the 
consumer to say what he wants ; the consumer is usually 
a person of sluggish intellect who does not know what he 



56 ECONOMICS chap. 

wants, and the middleman can to some extent control the 
consumer's wants, by advertising or other ways of pushing 
sales ; but his power in this direction is limited, and he 
could not carry on his business permanently by supplying 
customers with things which they do not want. In effect 
the middleman, whether merchant or shopkeeper, goes 
into the world of business and says to the producer, " Tell 
me what you produce and I will find you the man that wants 
it " ; to the consumer, " Tell me what you want and I 
will get it for you." He saves both producer and consumer 
trouble ; his profits are the charge he makes. 

The merchant arose before the " captain of industry." 
Trade grew up before the division of labour had been carried 
far enough to require the organisation of factories or work- 
shops ; for different regions have different capacities^ and 
by exchanging their products all benefit. With the growth 
of modern industry, however, the middleman's work has 
become vastly more important. Buying in the cheapest 
market and selling in the dearest, he is performing an im- 
portant part in the organisation of industry. A thing is dear 
where it is wanted, it is cheap where it can be produced 
easily ; the middleman therefore encourages production where 
production is cheap and discourages it where it is expensive, 
and at the same time directs goods from the places where 
they are wanted less to the places where they are wanted 
more. Commerce equalises the supply of goods in the 
different parts of the world ; a farthing a yard on the price 
of cloth will divert an order from one country to another, 
a halfpenny on the bushel of wheat from one continent to 
another. The localisation of industry is largely the result 
of the action of middlemen, and their function is a necessary 
function in an industrial organisation which enables the 
consumer to have dehvered at his door the products of 



Ill THE OKGANISATION OF PRODUCTION 57 

every country, obtained where they are produced most 
cheaply. 

Ill 

Methods of Appointing the Organisers of Production 

The organiser then, whether manufacturer or merchant, 
is the pivot of the modern industrial organisation. On 
the efficiency with which he organises the co-operation of 
speciahsts the efiectiveness of their work depends. On him 
the consumer depends for getting what he wants and not 
some make-shift. Specialisation is the principle on which 
al] increase in productive power depends — specialisation is 
effective only when the specialists co-operate, and with 
every increase in the degree of specialisation the work of 
organising the co-operation becomes more important and 
more difficult. 

It is of the utmost importance, therefore, to the 
material well-being of society that the right men occupy 
this position. If they do not, there will be waste ; in- 
efficiency there neutralises the efficiency of scores or 
hundreds and even thousands of specialised workers, just 
as an incompetent general can ruin the ffiiest army. In- 
efficiency in the organiser means that departments are 
held up because other departments are not ready for their 
product ; it means that some firms in the trade work over- 
time, while others are not fully employed ; it means that 
articles are produced that the consumer does not want and 
will not pay for, while articles he does want are produced 
in insufficient quantities and, consequently, are to be had 
only at a fancy price. The organisers control the capital 
of the country ; they decide, guiding themselves of course 
by reference to the demand of consumers, to what purposes 



58 ECONOMICS chap. 

it shall be applied and in what form it shall be applied. 
Want of judgment on their part may result in the creation 
of forms of capital which are useless — as, for instance, when 
mills are put up to meet an increase in demand which never 
comes. Originality and enterprise on their part, on the 
other hand, will make production cheaper and cheaper, 
since it will ensure the appUcation of capital in those forms 
and at those points where it is most productive. They are 
society's paymasters ; to them the consumer hands the 
price of the goods which he consumes ; they distribute it 
between the different classes of workers, capitahsts, and 
land-owners ; in a word they employ land, labour, and 
capital ; competition between land, labour, and capital 
for the national income takes place through the 
employer, and since the merchant employs the different 
employers in the same way as they employ land, labour, 
and capital, the competition between different trades for 
the national income takes place through the merchant. 
They " represent," as it were, the consumer in his relations 
with producers. Their function, in fact, whether they 
perform it ill or well, is the organisation of production ; 
the method of their appointment and payment is a most 
important question in social pohtics. 

We have looked at the organiser from the point of view 
of society to find out what is his position in an industry, 
his relation to different industrial classes, and the service 
he performs ; the resulting picture is one which the business 
man might not recognise as his own portrait. This is 
natural, since the view-point of society is different from 
that of any individual. The business man looks at industry 
simply as a series of market transactions ; he buys at one 
price and sells at another, taking the difference for himself 
or standing the loss if the difference is against him. There 



ni THE OEGANISATION OF PRODUCTION 59 

is no inconsistency between the view lie takes of himself 
and the view we have taken of him. Few people would 
recognise their own description by a physiologist or psy- 
chologist, but we do not therefore say that the descriptions 
given by physiology and psychology are untrue. At the 
same time it is necessary to guard against a possible mis- 
understanding. We have been trying to get at the work 
which the business man performs in the social organisation 
of industry. We have found that the present organisation 
of industry requires a class of organisers ; we shall find 
that it requires a class of risk-takers, and we find that the 
work of these classes is being done by the class of business 
men. We have not yet examined the question whether 
the business men, to whom the necessary and important 
work is allotted, do it well or not ; and in saying that the 
business men are the organisers and risk-takers of modern 
industry, we are not at all suggesting that the work of 
organisation and risk-taking is done perfectly or even as 
well as it might be. That depends entirely on the efficiency 
of the business men ; all that we have done so far is to 
bring out the necessity and importance of this work of 
organisation^ and we have now to enquire how the individuals 
who have the charge of this work come to occupy the posi- 
tions they do. 

How then are the organisers of industry appointed ? 
Some are appointed by the State ; the organisers of the 
German railways are so appointed ; most of the organisers 
of the tramway, electricity, water, and gas services in 
England are so appointed ; but such appointments are 
only a small proportion of the total number of organising 
posts in the community. It will be noticed that most of 
the instances of State appointments are in industries the 
services of which are consumed entirely within the area of 



60 ECONOMICS chap. 

the particular public authority. If the authority, therefore, 
is a representative body, we may say that these appoint- 
ments are made by the consumers. Similarly the organisers 
of the great body of industry under the control of the 
co-operative movement are appointed by the consumers ; 
the directors of the Co-operative Wholesale Society are 
appointed by, and responsible to, the customers of the 
Co-operative Wholesale Society ; indirectly, therefore, the 
customers control the appointment of the managers of 
separate departments. 

There is another form of " co-operative " effort which 
has attracted an amount of attention out of all proportion 
to its extent and success, i.e. the association of producers 
in what are called self-governing workshops or co-operative 
productive workshops. Their history offers a marked 
contrast to the success of the Co-operative Store and 
Wholesale movement. In them the organisers are appointed 
by the workers in the industrial unit, and no system of 
appointment has such a record of recurring failure. 
Obviously the discipline and order which modem methods 
of factory production require will be hard to secure when 
the manager is responsible to, and controlled by, the people 
he manages. During the nineteenth century a new form 
of business unit has grown to importance in the Joint- 
Stock Company, a form which we shall consider in detail 
when we are considering the organisation of capital. In its 
essence it is an association of capitalists large and small 
to carry on a business by the employment of paid organisers. 
Here the organisers are appointed by the capitalists ; the 
owners of the capital, the shareholders, elect the directors 
who do the chief work of organising. They in turn appoint 
managing directors and general managers who appoint 
the different subordinate managers. The ultimate control 



m THE OKGANISATION OF PRODUCTION 61 

here lies in the hands of the people who supply the capital 
of the business, and this method of business organisation 
is the most significant of the present time for two reasons — 
first, in it the ownership and the employment of capital 
are separated ; secondly, the work of organisation is 
separated from the bearing of risk, the former being 
done by specialised workmen for regular salaries, while the 
latter is undertaken by the shareholders to whom the 
profits go. 

Important, however, as are these methods of appointing 
organisers, and significant as they may be for the future, 
they are none of them the most general method of appoint- 
ing organisers at the present time. The great majority of 
the organisers in industry to-day simply appoint themselves. 
Since the Industrial Revolution the restrictions imposed by 
privileged gilds and corporations, and by the State itself, 
on the choice of occupations and freedom of trade have 
been relaxed, and a system of free enterprise or laissez-faire 
adopted. Laissez-faire is simply a policy of leaving any one 
free to set up business in any trade which he wishes. The 
State to-day does not, except in the case of a few professions, 
such as medicine and the law, prescribe special training for 
any occupation, or reserve by legal restriction the organis- 
ing posts in industry and commerce for any special class. 
So far as the law of the country is concerned, any one is at 
hberty to take up any organising work, that is to say, 
any one may start any business which he thinks will pay. 
In eft'ect, the community announces, " If any one thinks he 
can satisfy any want, let him start a business to do so : 
if he succeeds, he shall have the profits of his enterprise; 
if he fails, he and the people who have dealt with him 
shall bear the loss, for he will become a bankrupt." 



62 ECONOMICS chap. 

IV 

Merits and Defects of the System of " Free Enterprise " 

This freedom of enterprise is tlie chiief source of tlie 
elasticity of the modern productive organisation. Indi- 
viduals, being at liberty to avail themselves of any opening 
they can perceive, establish new businesses or adapt old 
businesses to every new want. The rapidity with which 
new inventions like the motor car and the kinema have 
been taken up and erected into important industries within 
the last generation, or the adaptability of the textile in- 
dustries to changes in fashion, will serve as illustrations of 
this elasticity. Freedom of enterprise is the cause also of 
the complexity of the productive organisation. The indi- 
vidual organiser, free to seek new markets for products and 
new sources of supply for wants, has spread a network of 
trade connexions over the whole world. The managers of 
manufacturing firms have been free to experiment and 
adopt any methods of organisation theyfoimd advantageous. 
Men of an organising turn of mind, who have seen a defect 
or a need in the existing organisation, have been free to 
establish businesses to remove the defect or satisfy the 
need ; while the men who have not the capacity to originate 
have been free to copy. The place of free enterprise in 
the organisation of production can be realised only by 
comparing the present system with the so-called " system 
of monopoly " which preceded it ; occupations were the 
monopoly of gilds and corporations which restricted 
entrance to them, methods of production were dictated by 
State or gild ofiicials, and the flow of trade was confined, 
so far as the State could control it, by prohibitive tariffs, 
tolls, and export duties to certain selected channels. 



Ill THE ORGANISATION OF PRODUCTION 63 

The principle which the opponents of this old 
" system of monopoly " sought to incorporate in the 
organisation of society is essential to any satisfactory 
organisation of production — the principle, namely, that 
production should be responsive to demand, and that 
individual organisers should be at hberty to experiment 
with new methods of production without waiting for 
the authorisation of some Government department. The 
method by which they sought to secure their object was 
also sound — the method, namely, of relying on individual 
initiative and sweeping away all obstacles to its wide- 
spread exercise. Their reform, however, stopped half-way. 
It was a negative, not a positive reform. It swept away 
obstacles to individual initiative without doing much to 
create opportunities of initiative. A constructive states- 
manship, therefore, even if it left the present system un- 
touched in principle, would seek to supplement the negative 
privilege of free enterprise by providing positive facilities 
at the public expense for research into processes of produc- 
tion, methods of organisation, and openings for trade, and 
by increasing the educational provision which is the chief 
aid to equality of opportunity. As things are, the system 
of free enterprise, with the other methods which we dis- 
cussed, has removed obstacles to the appointment of the 
most suitable people to the organising posts of industry 
and commerce without making provision to ensure that they 
shall be appointed. 

In spite of this defect, in the districts of Great 
Britain and the United States in which industry is most 
progressive, a majority probably of the responsible heads 
of firms have risen from the ranks, and a vast majority 
of firms have been founded by men who have risen 
from the ranks. The suitability of the small firm for 



64 ECONOMICS chap. 

the work of pioneering a new industry or new methods 
has provided the poor man of ability with his opportunity 
in some cases, a boom in an established trade in others. 
Latterly the growth of joint-stock enterprise and the 
extension of State and municipal enterprise have thrown 
open organising posts to men without capital. Few people 
would maintain, however, that the best men are in every 
important post, or that there are no incompetent men in 
important positions. In judging the efficiency of the system, 
therefore^ we have to consider not only the opportunities 
for the promotion of able men, but also the arrangements 
for removing from positions of control incompetent men. 
The arrangement on which the pohcy of free enterprise 
relies is failure through competition, and competition is not 
sufficiently efficacious. 

A large number of important posts in the organisation 
of industry and commerce are filled by hereditar}^ suc- 
cession. In the private firm the son can succeed the 
father without any enquiry as to whether he is the fittest 
man for the work ; hence large branches of industry are 
controlled by people who are put into their posts without 
any competition. Once in^ they can be removed only by 
their own resignation or by failure. Through failure, under 
the pressure of competition, the unfit are weeded out, but 
the doubt is suggested whether bankruptcy is not an 
unnecessarily expensive method of selection. A whole 
countryside may be ruined, because the son of the man 
who built up the business on which the countryside depends 
was born a fool. This danger is usually averted in their 
own interests by people who inherit businesses which they 
are not competent to manage, by the promotion of sub- 
ordinates to the position of partners, or by turning the 
business into a limited company. The elimination of the 



in THE OEGANISATION OF PRODUCTION 65 

unfit organiser by competition takes time, and during the 
interval in which he scrapes along he may do infinite harm, 
and at the best will cause great waste. 

A second defect in the appointment of the organisers 
is the extent to which class prejudice influences such 
appointments. The extreme case is the appointment of 
" guinea-pig " directors who receive the salary, even if 
they are not permitted by their colleagues to do the work, 
of organisers of industry. A more common but less obvious 
evil is the class feeling which makes the middle-class con- 
trollers of industry unwilling to give working men their 
fair chance. The working man of only average organis- 
ing ability will probably get few chances of showing he 
possesses it ; the working man of exceptional organising 
ability wiU not be kept back, but he has never so good a 
chance of promotion as the middle-class man of less excep- 
tional ability. Much organising work, the work of manag- 
ing and marketing, can be reduced to a routine. Before it 
is reduced to a routine it requires ability of a high order, 
and as such commands high payment. When it has been 
reduced to a routine it does not require exceptional ability, 
but frequently secures the same payment through custom, 
and because the middle-class person who usually has it to 
do lives at the same rate and in the same social style as the 
few able -men who are capable of work which is not routine. 
This is seen especially in the difference between starting a 
business and running one, between making a fortune and 
keeping it. The exceptional man builds up a business and 
makes a big income out of it : his ordinary son, who could 
never have built up such a business, is capable of running 
it, and makes as big an income out of it as his father. Only 
when he is below the average abihty and quite unequal to 
the work does he incur failure ; that is to say, so long as a 

F 



66 ECONOMICS chap. 

man is born into the social class which does most of the 
organising work in industry and commerce, and has merely 
the ordinary abiUty needed to maintain a traditional 
routine, the struggle for survival need not touch him. 
The owner of a large capital, who manages his business on 
conservative lines and chooses capable subordinates, is in 
no danger of losing his important position. 

Inequality of wealth is the great cause of inequahty of 
opportunity, since some capital is essential to starting in 
business. The amount needed on an average is growing 
greater, and the advantages of a large over a small capital 
are also growing greater. The privilege which the system 
of laissez-faire allows to every one to enter into competi- 
tion with established businesses is an empty one, unless it 
is accompanied by some means of getting the use of capital. 
The means exist — we shall study them in a chapter on the 
organisation of capital — but they certainly do not make the 
chances equal between middle-class and working-class men 
of equal a,bihty. Even in the large Joint-Stock concerns, 
which are opening new avenues of promotion to the poor 
but able man, the unconscious sympathy which middle-class 
people have for one another is probably an important 
influence in determining the exact selection of men for the 
most important positions. One great advantage which 
America has over the countries of Europe is that such 
class prejudices have less influence, and the career open to 
talent is more of a reahty than in more conservative 
countries. Dr. Marshall has explained that the working 
man who practises the vices of a miser, and restricts his 
life's activities resolutely to the making of money, can 
accumulate a considerable capital ; but he must have I 
" a long as well as a strong Hfe," and " patience, genius | 
and good fortune " if he is to succeed. Given these condi- ' 
tions, he may rise enough to enable his children to rise 



m THE ORGANISATION OF PRODUCTION 67 

further — if they also possess patience, genius, and good 
fortune. But the recognition of this possibiHty is not 
inconsistent with accepting Marx's generalisation that the 
-leadership of industry is an attribute of capital, just as in 
feudal times the functions of general and judge were 
attributes of landed property. 

A class of organisers similar to the business men in the 
present industrial system is necessary in any organisation 
of industry which avails itself of the economies of specialisa- 
tion. And in the sphere of organisation we can see the 
same speciahsing tendencies at work as in the rest of the 
field of industry. The Joint-Stock Company, in which all 
organising work is put into the hands of people who are 
specialised to it and is paid for by salaries, is gaining on 
the private firm, in which the work of organisation and the 
taking of risk are both performed by the owner of the 
capital. The taking of risks can never be quite separated 
from the work of organisation, as will be seen in the next 
chapter ; but it is significant that salaries as a method of 
paying for the work of organisation tend to displace profits. 



CHAPTEE IV 



SPECULATION AND INSURANCE 



Production as a whole carried on in Anticipation of 
Demand 

In the last chapter we saw that one part of the organisa- 
tion of production consists in buying things in one place 
and selling them in another. The middlemen or dealers 
who do this act as a connecting link between specialised 
districts and between speciahsed trades, and also as a 
connecting link between all kinds of speciahsed producers 
and the general body of consumers. This description, how- 
ever, gives only one-half of the work of the dealer ; the other 
half consists of the anticipation of demand, and of buying 
at one time and selling at another. We enter a shop, pay 
ten shillings, and a shirt is given to us. The shirt is the 
product of the labour of hundreds of people, the materials of 
which it is made were drawn from two or three continents, 
the macliinery required to make it took months to con- 
struct ; yet we get the shirt without waiting. For us to 
get it the shopkeeper must have stocked shirts, for him to 
do so the wholesaler with whom he deals must have stocked 
shirts, for the wholesaler to do so some one must have 

68 



CHAP. IV SPECULATION AND INSURANCE 69 

manufactured shirts, sonie one have manufactured the 
flannel from which they are made and the thread with 
which they are sewn, and further back still, some one must 
have made the machinery with which all these manu- 
facturers work. That is to say, in anticipation of our want 
of a shirt, a complex organisation must have been at work 
for months and perhaps years before we announced our 
want. We saw in the last chapter that a special class of 
organisers existed to connect the specialists up into one pro- 
ductive machine ; we see now that these organisers do this 
work, not in response to our demand, but in anticipation of it. 
We bought a woollen shirt ; suppose we had wanted a 
cotton one. The retailer would probably have been able 
to supply us. The demand for the different kind of shirts 
is fairly steady, and it is the retailer's business to know 
what to stock. But multiply our case a thousandfold, and 
suppose he has not anticipated our wants so exactly. What 
is the result then ? First, he has woollen shirts which are 
not wanted, and all the series of people behind the counter, 
who have been contributing to the making of his woollen 
shirts, have been making something which, as it happens, 
is not the thing wanted. Secondly, the shopkeeper, being 
unable to sell woollen shirts, orders fewer, and this check to 
the demand for woollen shirts is transmitted right through 
to the people who grow wool and make woollen-working 
machinery. Meanwhile, we, in our determination to get a 
cotton shirt, leave the shop and go elsewhere for it, and the 
shopkeeper telegraphs to his wholesaler for a supply of 
cotton shirts at the same moment as we at another shop 
are asking for a cotton shirt. Imagine a thousand people 
acting as we are acting, and the people whose business it is 
to supply cotton shirts will get the impression that there 
is going to be an increased demand for cotton shirts and 



70 ECONOMICS chap. 

will place their orders accordingly. Or suppose we were 
attracted by a brilliant and original tie, or a new thing in 
braces, or suddenly remembered that we want a straw hat, 
and, having only ten shillings in our pockets, decided that 
the shirt could wait ; then the trade both in woollen and 
cotton shirts would be disappointed, and we should be 
helping a boom in ties, braces, or hats. There are similar 
possibilities at each stage in the productive process. The 
wholesale merchant buys from the merchant what he 
thinks will be wanted ; the merchant stocks or has ordered 
from the manufacturer what he thinks the wholesaler will 
want ; the manufacturer (unless he is working to a mer- 
chant's orders) is similarly estimating what will be wanted ; 
and the machine - maker, the labourer, the agriculturist 
similarly direct their efforts to making or growing what they 
anticipate will be wanted. 

Production is carried on in anticipation of demand. 
This is inevitable if we are to avail ourselves of the econo- 
mies of specialisation, since speciaHsation talces time. When 
we purchased the woollen shirt we were getting goods from 
the Australian sheep farmer, from the American cotton 
grower, from a whole host of machine-makers, builders, 
transport workers and others, who could not possibly have 
known of our existence nor anticipated for themselves 
what we should want. Again, all the processes of manu- 
facture must be carried on simultaneously. The growing 
of the wool, the spinning, the weaving, the shirt-making, 
and the distributing by merchajits aiid shopkeepers must 
be going on continuously and simultaneously, or a large 
number of people and large amount of capital would be 
unemployed. The shirt which we bought was perhaps 
begun two years ago, and with every stage in its manu- 
facture the materials of which it was made become more 



IV SPECULATION AND INSURANCE 71 

and more useless for anything except the one purpose of 
making a woollen shirt. 

Production is carried on ahead of demand on an 
estimate of it. Working on an estimate necessarily involves 
the risk of loss when a wrong estimate has been made, 
and every class in the community has to some extent 
to meet this risk and bear a share of this loss. The 
consumer suffers because he does not get what he wants, 
or has to pay a high price for what he wants ; the worker 
suffers because his specialised skill may suddenly lose its 
value. But the chief risk is borne by the class of organisers 
whom we studied in the last chapter. They take the first 
and chief loss if something is made which turns out not to 
be wanted. This is so because they have paid for the 
making of the thing before they could find out that it is 
not wanted ; in return, they take the profit if their estimate 
of what is wanted turns out to be correct, so that they are 
able to offer the public just what it wants and is willing to 
pay for handsomely. They are the class in industry whose 
business it is to anticipate demand, to divine what will be 
wanted and how much of each thing will be wanted, and 
their profits and losses depend as much on the correctness 
of their anticipation as they do on the skill with which they 
organise specialised producers. This side of their work is 
emphasised by the French term for the person who organises 
production, entrepreneur, which implies undertaking pro- 
duction for the market with its attendant risks. 

II 

Speculative Dealing 

There is thus a speculative element in all business, due 
to the fact that it is carried on ahead of demand on an 



72 ECONOMICS chap. 

estimate of demand. When, however, we speak of specula- 
tion, we do not as a rule refer to this anticipation of demand. 
We should not call the action of a retailer in stocking his 
shop " speculation," although there is in it the risk that 
the public will not want the stock he has selected. By 
" speculation " we mean the kind of business carried on by 
the dealer in cotton or wheat, and the word carries with it 
a suggestion of socially harmful action. A study of the 
nature and social effects of this speculation will throw 
light not only on the trades in which it is carried on, but 
on the organisation of production as a whole. 

The essence of speculation lies in forecasting price 
movements and then buying or selling for a profit. Having 
made his forecast, the speculator buys if he thinks prices 
are going to rise, sells if he thinks prices are going to fall. 
He looks to the future and works on an estimate ; he takes 
the risk of loss if his forecast is wrong in return for the 
chance of gain if his forecast is right. 

To discover the social effect of his action, it is necessary 
to enquire what he bases his forecast on, or, in other words, 
what are the influences that cause price movements. These 
influences are changes in the supply of the commodity he 
is dealing in and changes in the demand for it. He forecasts 
price movements by anticipating what the changes in the 
supply of the commodity or the demand for it are going 
to be : an increase in the supply or a falling off in the 
demand will cause prices to fall, a shortage in the supply 
or an increase in the demand will cause prices to rise. Hence 
the anxiety with which all the influences that can affect 
either the supply of or the demand for any of the staple 
commodities of commerce are watched and reported ; 
the prospects of rain in Australia, on which the wool 
chp so largely depends, frost in the cotton belt of the 



IV SPECULATION AND INSUEANCE 73 

United States, the weather in wheat-growing regions, are all 
under constant observation, and a steady succession of 
estimates of the coming yield in these regions is sent to 
the marketing centres. Similarly the demand is watched ; 
the prospects of trade in all departments are the daily 
study of thousands. Every daily paper has a consider- 
able proportion of its space devoted to market reports, 
in which all the information is given which the paper 
can collect bearing on the probable changes in the 
supply of, and the demand for, the chief staples and local 
products. 

Let us suppose that the dealer's forecast is correct. 
Anticipating a shortage with no corresponding falling ofi 
in demand, he expects prices to rise ; he therefore buys, 
intending to sell at a profit when the prices have gone up. 
His buying tends to send prices up now, higher prices tiow 
check consumption now. Hence present stocks are not 
exhausted so rapidly ; some is saved for future use, and so 
eases the pressure on the short supply which our speculator 
rightly anticipated ; in that way prices are prevented from 
rising so high as they would have done but for his action. 
Or suppose he anticipates an increase in supply and a 
consequent fall in prices ; he sells forward {i.e. he offers 
goods for future delivery at a price lower than the price at 
which they can be obtained for immediate dehvery) ; his 
selUng now tends to bring prices down, the lower prices 
stimulate consumption at once, so that present stocks are 
cleared and are not there to cause a glut when the big 
supply, which the speculator anticipated, comes into the 
market. Similarly, he will buy in anticipation of a rising 
demand, sell in anticipation of a falling demand ; his action 
afiects prices, so that a sudden change in demand does not 
produce a sudden change in price. It is, of course, the cumu- 



74 ECONOMICS chap. 

lative action of a large number of dealers in a sensitive 
market that has this effect. 

Speculation, then, buying and selling for a profit on a 
forecast, tends, if the forecast is correct, to lessen price 
fluctuations, by averaging supply and demand over a long 
period. The speculator, by varying prices, stimulates 
and checks consumption, always ahead, of the change in 
supply or demand. This is a social service, provided that 
price fluctuations are inevitable, since sharp price move- 
ments mean fortunes for a lucky few, bankruptcy, unem- 
ployment, and distress for the many; the interest of the 
community Ues in steady prices. The speculator corresponds 
to the governor on a reciprocating steam-engine. 

It follows that, if the speculator's forecast is wrong, hia 
action will be socially harmful, since it will accentuate 
price fluctuations. If, for instance, he sells, thinking that 
prices are going to fall when they are really going to rise, 
his selHng will for the moment tend to force prices down 
and stimulate consumption, so that when prices do go up 
they will go up higher than they would have done but for 
his action ; and vice versa. Hence speculation, if it is to 
perform a social service, must be confined to specialists 
who are not likely to be wrong in their forecasts ; the 
outsider coming into any market is a social nuisance. 
Society is not entirely defenceless against incompetent 
speculators. If the forecast is wrong, the speculator makes 
a loss and sooner or later fails ; but so long as he continues 
to operate he is a dangerous nuisance, and in his ruin, when 
it comes, he will probably involve others. Dealers, of 
course, do not look at themselves in this way. They 
look at their business simply as buying at one price and 
selling at another.. They look at their business from the 
point of view of the individual, while we are looking at it 



IV SPECULATION AND INSURANCE 75 

from the point of view of society. From the points of view 
of both individual and society the speculator's profit is a 
difference in price ; from the social point of view, however, 
the important thing is that the speculator's action tends to 
lessen the price fluctuations out of which he makes his profit. 

Are these price fluctuations then inevitable ? It is 
only if they are inevitable that the speculator's action is 
necessary and his profits at all justifiable. In the present 
state of science, and in an organisation of industry that 
avails itself of the productive economies of specialisation, 
it must be said that they are inevitable. They are due to 
two main causes which we will consider separately, fluctua- 
tion in demand and fluctuation in supply. 

Fluctuation in demand occurs because what people want 
and how much they want is always changing. It changes 
with fashion — the " hobble " skirt almost halved the demand 
for certain important classes of textiles ; it changes with the 
weather — a wet summer reduces the demand for musHns, 
silks, and flannels, while it increases the demand for water- 
proof fabrics ; it changes with the general changes in 
prosperity. A war will cause a sudden and enormous 
demand for blankets, khaki, socks, boots, besides arma- 
ments, a demand which ceases just as suddenly when the 
war ends. Strikes and lock-outs are a similar influence of 
less importance. The demand for one commodity is in- 
fluenced by its substitutes : when wool is dear, the demand 
for cotton will increase ; when cotton is dear, the motive for 
substituting it for more expensive fibres will be weakened. 
Industry cannot wait until demand has expressed itself, 
methods of industry being so round-about and prolonged. 
Production is carried on ahead of demand on an estimate of 
it ; some one has to make that estimate ; that " some one " 
is a speculator. 



76 ECONOMICS chap. 

More important, however, to the speculative dealer are 
fluctuations in supply, and speculation, in the narrow sense 
of the word, is found chiefly in the trade in raw materials 
such as cotton and wool, and food stufis such as wheat, 
sugar, coffee, where fluctuations in supply are greatest. 
They are greatest here, because the supply is not altogether 
under man's control ; man may decide how much land to 
sow or plant, the weather will decide what product the land 
will yield. Moreover, the supply of these commodities does 
not come into the market in a regular and even flow ; it 
comes in gulps, after the harvest in each producing region. 
The demand, on the other hand, is continuous and fairly 
regular ; for industry must be continuous. Cotton mills 
need cotton every month of the year, although cotton is 
harvested only two or three months in the year. Similarly, 
people want food all the year round, even though food is 
being harvested in one region during only a few weeks in 
each year. These two characteristics of trade in produce, 
the effect of weather and other natural influences on the 
amount of the supply in any year, and the seasonal or 
irregular nature of the supply as compared with the con- 
tinuous and regular nature of demand, explain the specula- 
tive character of produce-dealing. 

The importance of changes in the supply of, and the 
demand for, commodities is due largely to the fact that they 
are immediately reflected in prices ; and the prices affected 
are not merely those of the raw material, but also those of 
all the commodities into which the raw material enters. 
A change in the supply of wool will affect the values not 
only of stocks of wool, but of tops, yarns, and pieces ; a 
frost in Texas will cause an immediate rise in the prices 
asked not only for raw cotton in the United States, but for 
raw cotton in Lancashire and for yarns and pieces. Thus 



IV SPECULATION AND INSURANCE 77 

a change in values often occurs between the commencement 
and the completion of a single process of manufacture. A 
spinner may buy tops to spin, and, when his yarn is com- 
plete, find the value of it enhanced by the fact that wool 
has gone up ; a top-maker may buy wool in Sydney at one 
price, and get it to England only to find that some change 
in the conditions of the market has brought prices in 
England below the level at which he bought in Australia. 

SpeciaUsation, then, introduces two inevitable risks into 
production which are absent from the primitive system 
under which each household produces the bulk of its own 
needs. The first is the risk that the estimate of the demand 
on which producers have acted will be wrong ; the second 
is the risk that some change in supply, occurring after a 
process of production has been begun, will lower prices, so 
that the value of the product when completed will be less 
than the cost of production. The first risk arises from the 
fact that speciaHsation takes time, so that production has 
to be carried on in anticipation of demand ; the second 
arises from the fact that industry, to be economical, must 
be regular and continuous, while the supphes of the most 
important raw materials are irregular and discontinuous. 
The risks mean occasional loss, the chances of profit are 
presumably equal. If the person who undertakes the risks 
can anticipate correctly the movements of demand and 
supply, he will always make profits and no losses. The 
profits of the dealer are the payment society makes for 
the work of anticipating demand and supply. 

It is conceivable, though unhkely, that these two risks 
involved in the organisation of production on a basis of 
speciaHsation might be ehminated. The risk due to fluctua- 
tion in demand could be eliminated by carrying on all 
production to order : we should not go to a shop and buy 



78 ECONOMICS chap. 

a woollen shirt, we should order it three years before we 
wanted it, in order that the wool producer might increase 
the supply of wool and other producers their facilities 
for handling it. To state this alternative is to show its 
inconvenience. The risk due to fluctuations in supply 
could be overcome by accumulating and maintaining a 
reserve or reservoir of produce from which to meet and 
regularise natural fluctuations in supply ; this method 
was applied by Joseph to meeting the difiiculties of 
Egypt under Pharaoh. The expenditure involved in 
establishing such a reservoir, however, and the capital 
tied up in it, would be enormous, making it possibly more 
expensive than the present system, and the existence of 
such a market for their produce might tempt growers to 
produce in excess of society's normal requirements. 

Ill 

The use of Contracts to shift Specidative RisJcs on to 
the Shoulders of Dealers 

The risks and profits of anticipating supply and demand 
ar6 not taken by all businesses alike. By the use of con- 
tracts the risks of incorrect anticipation can be concentrated 
at a few points, so that most of the people in an industry 
know nothing about them and are enabled to work as if 
they did not exist. An industry as a whole cannot work 
to order, but any firm in an industry and even whole stages 
in it can. By working only to contract a large number of 
firms, so to speak, " contract out of " the risk due to price 
movements, leaving other firms to speciahse in forecasting 
these movements, and to bear the risks attaching to them 
in return for the profits to be obtained by correct anticipa- 
tion of them. 



iv SPECULATION AND INSURANCE 79 

The tailor will keep only a small stock of cloth, but 
a large number of patterns ; he will buy the cloth only 
when the customer has chosen his pattern. Manufacturers 
in the worsted industry complain that merchants try 
to do the same, buying only when they have an order, 
and thus throwing on the manufacturer the burden of 
meeting fluctuations in the demand. The manufacturer 
in some cases, however, never makes for stock ; he weaves 
patterns and sends them out, and manufactures pieces only 
to order. The spinner usually spins only on contract, i.e. 
the price which he is to receive and the amount he is to 
make are settled before he buys his material. But in 
every industry we reach at some point a stage or a group 
of firms which cannot wait for orders and then buy just 
sufficient raw material to meet their requirements at a price 
leaving them a profit ; they cannot, because they draw their 
material direct from Nature. They have not a continuous 
supply to draw on ; they have to buy when the harvest 
comes, without waiting for orders. They may buy up in the 
course of two months a year's supply of raw material. 
Again, the manufacturer, having got his order, can cover 
himself against loss due to a rise in the price of yarn 
before he has completed his order, by giving a contract 
now, while prices are at a level that ensures him a profit, for 
all the yarn he will need ; the spinner can cover himself 
against the same risk of loss by giving a contract for his 
material as soon as he has got his order for yarn. But 
again there are firms that cannot cover. In the worsted 
industry the top-maker undertakes to supply tops or wool 
at any time of the year, but he cannot buy at any time ; he 
has to buy when the wool comes ofi the sheep's back, and 
the bulk of the supply is crowded into three months of the 
year. And behind him the farmer cannot wait for orders 



80 ECONOMICS chap. 

and limit his production to the amount of his orders, since 
the amount of his product depends so largely on the weather. 
By working to contract, and covering themselves by giving 
contracts for their materials, those firms that can do so 
forego the chance of gain from price fluctuations in return 
for security against loss from price fluctuations. The 
fluctuations remain, the risks and chances from which they 
contract out are not eliminated. What happens is that the 
risks of loss and the chances of gain are concentrated on the 
shoulders of middlemen— retailers and merchants at one 
end of the productive process engaged principally in anti- 
cipating demand, dealers at the other end principally in 
anticipating movements of supply. 

Thus the use of contracts enables one of the great draw- 
backs of specialisation, namely the risks which it introduces 
into business, to be counteracted by a further appUcation 
of the principle of specialisation, namely, the speciaUsation 
of dealers to the work of anticipating and bearing those 
risks. Even where a single firm undertakes both the 
organisation of the processes of manufacture and the work 
of anticipating and bearing the risks of the market, the 
tendency to-day is for the two pieces of work to be put into 
different hands. The former is done to an increasing extent 
by salaried servants ; the latter tends more and more to 
be the special work of the head of the firm, assisted by 
other salaried servants. These make it their business to 
collect all possible information as to the supply of, and the 
demand for, the goods in which they deal. They acquire 
a special knowledge of the possibilities of public taste and 
fashion, of the sources of the raw material, of all the special 
risks incidental to the trade ; and they can allow for all the 
special risks in quoting a price for goods to be delivered 
some time in the future. They could not give the reasons 



IV SPECULATION AND INSURANCE 81 

for their decisions ; but their judgment has the same groimd 
of special experience that the skill and judgment of any 
other speciahsed worker possesses. 

They are helped by the organisation of trade in markets. 
A market was originally a place where buyers and sellers 
could meet. To-day they may still meet in a customary 
place, but cheap travelling and cheap communication have 
made the market-place no longer essential to business. 
The trade in every important commodity has a whole 
apparatus of aids to right judgment of the chances of the 
trade. The Exchange is the most important of these, 
where is concentrated the latest information as to quantities, 
prices, and sales, and rules are enforced to make business 
as simple and open as it can be made. The trade news- 
paper, or the business columns in the local newspaper 
where a trade is localised, give some information. An im- 
portant part of the work of the Board of Trade and the 
government consular service is to keep business men 
posted in the wants and needs of foreign markets. And 
every trade includes in its working army a corps of scouts 
or skirmishers in the form of agents, travellers, and others 
who are in constant touch with customers, finding out the 
nature and extent of their future demand. What is called 
specially the " business side " of a firm is the machinery 
which society has devised for anticipating demand, since 
specialisation requires production in anticipation of demand. 

A comparison of the chief textile industries will illustrate 
the tendency to specialisation in risk-taking. In the cotton 
industry, which is the most advanced, the degree of speciahs- 
ation is very great ; manufacturers and spinners as a rule 
work chiefly to order, and contract for their raw material at 
the same time as they take the order for their product ; the 
risks due to price-fluctuations are taken almost wholly by 

Q 



82 ECONOMICS chap. 

dealers in the raw cotton and by piece-merchants. In the 
woollen industry, the least advanced, there is little speciali- 
sation. It is usual for a firm to undertake all the processes 
of manufacture, and for the manufacturing firm to take the 
risks of dealing. In the worsted trade, which occupies an 
intermediate position between the other two, the risks are 
fairly widely shared, but there is a tendency for them to 
concentrate on middlemen, especially on the top-makers, 
the dealers in the raw material. The top-maker now very 
largely buys direct from Australia, risking a fall in values 
while the wool is in transit. He buys the rest of his stock 
in large quantities at a limited number of wool-sales ; he 
will sell at any time. He will contract to supply spinners 
at any time, but he cannot get any one to contract to supply 
him. He needs a high degree of technical knowledge to 
deal in the wool, but his profits are chiefly obtained from 
forecasting price-movements. 

Now this tendency for speculation to concentrate in the 
hands of dealers is in accordance with the general tendency 
of economic development for work to be specialised ; the 
dealers are in constant touch with the market at many 
points, and they have no mill to manage. It is a desirable 
tendency, since we have seen it is essential if speculation 
is to perform a social service, that it should be well done, 
that the speculator's anticipations should be accurate ; 
and this can be secured only by people specialising in 
speculation. Moreover, different qualities are needed for 
dealing and for manufacturing, and the best organiser of a 
mill is not necessarily the best judge of price-movements. 
The reason that the tendency is not more general is that 
speculation, when successful, pays. The successful antici- 
pation of price-movements is the quickest way of making 
a fortune offered by the modern economic organisation, 



IV SPECULATION AND INSURANCE 83 

and manufacturers are loth to relinquisli the chance of 
such gains, even in return for security against loss. Hence, 
to take the same example as we took before, in the worsted 
industry only combers and dyers, who work exclusively on 
commission, and commission spinners and commission 
manufacturers, keep absolutely clear of the speculative 
field ; they have their own risks, from trade fluctuations, 
but they are not concerned with the gains and losses that 
come from price-fluctuations. Spinners and manufacturers, 
who have the capital to do it, although as a rule they work 
to order and contract for their raw material, are usually 
open to buy up raw material when it seems cheap, and to 
work for stock when orders are not coming in. Both 
operations are speculative, since prices may change between 
the time when they buy the raw material and the time when 
they have completed their product ; if prices rise they will 
make a pi:ofit over and above the normal profit of manu- 
facture, if prices fall they will make a loss. It is because 
speculation is so much more specialised in the cotton trade 
than in the worsted trade that joint-stock companies are so 
much more common in the former than in the latter. 
Joint-stock enterprise, as we shall see in the next chapter, 
is well-adapted to the conduct of the manufacturing opera- 
tions of a trade, while the private firm is more suited to 
dealing with its speculative element ; in the cotton industry 
manufacturing operations and dealing are kept apart, in 
the worsted industry they are often combined. 

IV 

Terminal Markets for dealing in Futures 

A refinement of speculation, leading to a further con- 
centration of risk-taking, exists in the terminal markets 



84 ECONOMICS chap. 

for dealing in futures, whicli are now found in connexion 
witli the trade in many raw materials and food-stuffs. 
Their nature will be understood best perhaps by an account 
of a single one of them. In England you can buy tops for 
future delivery, but you will have to take delivery ; in 
Roubaix-Tourcoing, the chief French woollen centre, you 
can buy the standard top for delivery any month up to 
twelve months ahead, and, at any time before delivery 
becomes due, cancel the contract by paying (or receiving) 
the difference between the price at which you made the 
contract and the price at which the top stands now for 
delivery in the month of the contract. The essentials of 
this organisation for dealing in futures are an official price- 
list, a class of brokers, and a clearing-house and bank. In 
Roubaix-Tourcoing the list is published after morning and 
afternoon business ; it gives the price at which the standard 
top can be bought for delivery any month up to twelve 
months ahead, and is based on information of business done 
which is supplied by the brokers. The brokers are bound 
to give this information ; they are not allowed to buy or 
sell on their own account. The clearing-house with which 
all transactions on the market have to be registered is called 
the Caisse de Liquidation et Guarantie, and it controls 
the market by guaranteeing that accounts shall be paid. 
The unit of dealing is the filiere or " lot " of five thousand 
kilograms. 

Suppose I wish to buy futures, I must act through a 
broker, who finds a broker acting for some one wishing to 
sell ; buyer and seller must both through their brokers 
register the transaction with the Caisse, and must both 
within twenty-four hours make a deposit with the Caisse 
of 1000 francs per fiUere. Then every time the list shows 
a change of five centimes per kilo, either the buyer or seller 



IV SPECULATION AND INSUEANCE 85 

must pay in to the Caisse the difierence ; if the price has 
gone down, the buyer pays ; if it has gone up, the seller 
pays. For example : I buy 5000 kilos for delivery in 
October at 6' 10 francs per kilo, and deposit 1000 francs. 
Suppose the price falls to 6'05 francs, I pay in to the Caisse 
the difference (250 francs). The value of the tops to which 
I am entitled in October is now only 6'05 x 5000 francs ; I 
have contracted to pay for it 6"10 x 5000 francs ; therefore, 
to ensure my ability to pay, the Caisse insists on my deposit- 
ing the difierence. The price rises to 6" 10 again, and I with- 
draw my 250 francs. It rises still further to 6'15, and the 
seller has to deposit 250 francs ; he has contracted to deliver 
tops in October in return for a payment of 6" 10 francs per 
kilo, he will not be able to get them for less than 6*15 per 
kilo ; he must therefore provide the difierence. The result is 
that when October comes there will be in the Caisse not only 
the original deposit but also an additional deposit, equal to 
the difierence between 6*10 francs per kilo (the price at 
which the contract was concluded) and the current (or 
" spot ") price for the top. If the current price in October 
is higher than 6*10 francs, the seller will have deposited the 
difierence, and with this deposit and the 6*10 x 5000 francs 
which he will receive from the buyer, he will be able to pay 
the current price for the tops and deliver them. If the 
price is less than 6*10 francs, I, the buyer, shall have de- 
posited the difierence, and having this deposit at my dis- 
posal shall be able to pay 6' 10 x5000 francs, although the 
tops are not worth that sum at the current price. The 
essential thing in this arrangement is not the original 
deposit (which is merely an additional security for solvency, 
required on this particular market) but the regular payment 
of " difierences " as they occur. On this account, it is the 
exception to take delivery ; nearly always, some time 



86 ECONOMICS ceap. 

before delivery becomes due, the buyer accepts or pays the 
difference due to him or from him and cancels the contract. 
What the buyer buys is not so much wool to be dehvered 
in October, as security against loss from an unfavourable 
movement of prices between the time when he makes his 
contract and October ; the transaction in fact is a kind of 
insurance. This will be clearer if we consider who use the 
terminal market. 

The sellers of futures are usually either importers of 
wool or manufacturers or spinners working for stock. Their 
object is to hedge. The importer having bought in South 
America, is anxious to protect himself against the loss he 
would suffer if prices fall while the wool is in transit more 
than he has allowed for in deciding what price he could pay. 
He therefore wires to his representative at home to sell 
futures for the month when his wool will have reached 
Eoubaix. If the prices have fallen by the time the wool 
reaches Roubaix, his loss on the sale of it will be balanced 
by a gain on his future transaction, for prices wiU have fallen 
in the futures market as well as " spot " prices, and the 
person who bought his future will have to pay him the 
difference. Similarly, a manufacturer working to stock 
will sell futures ; then if prices fall to such an extent that 
they do not cover his costs and he has to sell his product 
at a loss, he will have his futures transaction to compensate 
him, since there will have been a corresponding fall in prices 
there ; and the buyer of his future will have to pay him the 
difference. Of course the hedge is not complete, and such 
as it is, it is secured only by sacrificing the chance of a gain 
from prices going up ; but where large opei-ations are being 
carried on on a limited capital, the security obtained by this 
method will usually lead to its adoption. The buyers of 
futures are merchants and top-makers of different kinds 



IV SPECULATION AND INSURANCE 87 

who have contracted to supply wool, tops, or yarn for some 
time ahead. They " cover " themselves by buying futures 
to an equivalent amount and for the same time ahead as 
their contract. Then if prices rise more than they antici- 
pated and they have to pay for the wool, tops, or yarn more 
than they will get under their contract, the loss will be 
covered by the profit they will realise on their futures owing 
to the rise in prices. Similarly, spinners and manufacturers 
will sell futures, if they do not wish to give a contract for 
their raw material, and yet wish to cover themselves from 
loss due to a rise in prices. None of these buyers probably 
will take delivery of the tops they have bought when the 
future matures, because the top which the seller can tender 
may not be suited to their purposes ; they will simply take 
the difference — and it will enable them to purchase without 
loss the exact kind of wool, top, or yarn they want. All 
these buyers and sellers sacrifice a chance of gain to insure 
against a possible loss. 

There is yet another class of buyers and sellers. The 
importers, spinners, and manufacturers, who avail them- 
selves of the terminal market to insure themselves against 
loss from price-fluctuations, have not abolished those fluctua- 
tions ; if they do not take the risks, some one else must. 
The most important persons in future dealings are those 
dealers who act as middlemen between the buyers and 
sellers described above. They are always willing to buy 
or to sell, provided they can get their price ; hence it is 
they who really fix the prices of futures. They make a 
living solely by forecasting movements of prices, and buying 
or selling to make a profit. Their work is speculation pure 
and simple, since they never use the material in which 
nominally they deal. Their work represents the highest 
degree of specialised risk-taking, and is justifiable, since 



88 ECONOMICS chap. 

their buying and selling will tend to even price-fluctuations, 
so far as the forecasts on whicli their profits depend are 
accurate. 

Thus a futures market concentrates at one point, almost 
one might say on one price-list, the forecasting of price- 
movements. It tends to concentrate the work of specula- 
tion on one class who do nothing else, enabling the manu- 
facturer, distributor, and importer to cover themselves or 
hedge against any loss from price - fluctuations. The 
advantages of the institution are obvious ; its disadvantages 
are equally obvious. It makes the separation between the 
speculative side and the technical side of dealing so com- 
plete, that outsiders, who have no technical knowledge of 
the trade and no stake in it, are able to come in and 
speculate. By substituting the payment of " differences " 
for the payment of the full price of the commodity dealt in, 
it provides a further encouragement to outsiders to come in 
and gamble, and tempts dealers with small capitals to 
undertake operations that require for safety a larger capital 
than they possess ; it is in fact an encouragement to 
gambling. At the same time this economy of capital is a 
great advantage, since the moving of cotton for example 
from the United States to Lancashire is such a large opera- 
tion and crowded into such a short space of time that it 
could hardly be carried out on a basis of full money pay- 
ments. The existence of the price - list results in " un- 
official " speculation outside the organised exchange or 
market, out of their control and subject to none of the strict 
regulations imposed by them to prevent gambhng. Finally 
it is alleged that organised future dealings, by making the 
market more delicate and sensitive, make disturbance more 
easy and facilitate the artificial price-movements of which 
we have to speak in a moment. It must be remembered, 



IV SPECULATION AND INSURANCE 89 

however, that speculation is not confined to futures ; it is 
inherent in all trade. The futures market merely con- 
centrates, and perhaps multiplies it. There is as much 
speculation in the worsted industry in Bradford, which will 
have no terminal dealing, as in Roubaix, which ha^ organised 
and clung to its " terme " in the face of the persistent 
attacks of other French woollen centres. 

V 

Illegitimate Speculation 

Having described the nature and effects of speculation 
in general, we are now in a position to discuss what kinds of 
speculation are illegitimate. Two prehminary observa- 
tions may be made. Mere buying and selling by people 
who neither produce nor use the material dealt in is not 
necessarily illegitimate ; as we have seen, the buying and 
selling of an expert, who accurately forecasts the movement 
of prices, has the effect of lessening the price-fluctuations 
out of which he makes his profit. Secondly, we cannot at 
present look for a canon of legitimacy to the motive of the 
speculator. He is often neither conscious of, nor interested 
in, the social effects of his action, looking only to his private 
profit ; he represents his business to himself as merely 
selling at one price and buying at another, and the margin 
between the two that he aims at can be secured by hurting 
as well as by serving society. It is the effects that justify 
or condemn speculation. 

We can begin by declaring illegitimate and wrong any 
speculation by the outsider. Every material dealt in 
requires careful study, and the outsider who has not made 
this careful study is not likely to estimate accurately the 
force of the different influences affecting its supply and 



90 ECONOMICS chap. 

demand. If his anticipations are wrong, his action will 
accentuate instead of lessening price-fluctuations, and may 
upset the calculations of legitimate dealers who have given 
all their time and efforts to studying the material. The 
outsider then, who comes into any market to speculate, is 
a social nuisance. It should not be necessary to state this, 
but successful speculation is so profitable that people are 
tempted to ignore the dictates of common sense. 

The second kind of illegitimate speculation that we can 
distinguish is deahng on insufficient capital, A dealer 
should obviously not engage in transactions so great that, 
if his forecast of prices is wrong, his loss will amount to 
more than his capital. If he does, he is risking bankruptcy, 
which will involve others, on the chance of making a fortune ; 
if his forecast turns out to be correct, he rakes in big profits ; 
if it is wrong, he is unable to fulfil the obligations which he 
contracted, and is not only ruined himself — it is perhaps 
as well that he should be — but involves in his ruin others 
who had relied on his contracts. Expecting a fall, he sells 
forward ; a rise instead of a faU in prices takes place, and 
he is unable to deliver the goods which he sold and on which 
his customers are relying. It is this kind of dealing on 
insufficient capital that is chiefly responsible for the evil 
associations of the word " speculation." It is a variety of 
the old game of " heads I win, tails you lose." 

The third, and worst, kind of illegitimate speculation 
consists in producing artificial price-fluctuations. Industry 
as a whole, we have seen, is carried on not in response to 
demand — with the price to be received for the product 
settled before the production is begim — but in anticipation 
of demand, with the price a matter of uncertainty till the 
whole process of production is completed by the transfer 
of the product to the consumer across the shop-counter. 



IV SPECULATION AND INSURANCE 91 

This fact forces upon industry the need of forecasting the 
movements of prices, in order to prevent an expenditure on 
producing a thing greater than the price which the thing 
will fetch when produced. This forecast is made on the 
assumption that prices are the outcome of the interaction 
of supply and demand. It is assumed that a rise in price 
indicates either a coming shortage in supply or an increase 
in demand, a fall in price either an increase in supply or a 
falling off in demand ; if the assumption is not justified, 
business becomes the merest guess-work. Price is the 
indicator that business follows. 

Now it is possible to falsify this indicator, and to pro- 
duce price-movements which are not the outcome of the 
interaction of supply and demand. This is done in 
two ways ; first, by spreading false reports as to the 
state of supply or, less frequently, of demand ; second, 
by buying or selling in direct opposition to one's fore- 
cast of price - movements in order to accentuate price- 
fluctuations. For example, an operator, or syndicate of 
operators, who believe that prices must go up owing to a 
coming shortage in supply, will spread reports that there is 
going to be a glut or a falling off in demand. This will give 
the impression that prices are going to fall. But more 
effective than any report in creating that impression will 
be their action in the market. By sudden and extensive 
sales forward they will force prices down ; other people, 
who would normally have followed the indications of the 
market and bought for a rise, will think that the operators 
are acting on private information and will therefore follow 
their example and sell, thus helping to force prices still 
lower. Meanwhile the syndicate will secretly have been 
buying up all they can get ; when prices have been forced 
down as far as they are likely to go, they will buy openly 



92 ECONOMICS chap. 

also, and perhaps be able to secure a large proportion of the 
entire supply for months ahead. As a result of the shortage 
which they foresaw and which now operates unchecked, 
prices will rise high ; as a result of the syndicate's sudden 
and extensive buying they will rise higher than would other- 
wise have been the case, and the syndicate's profits will 
consist, not merely of the margin between the price ruling 
when they foresaw the coming shortage and the price ruling 
when that shortage began to be felt, but of the much wider 
margin between the level to which they artificially depressed 
prices and the level to which they artificially raised them. 
Such action is easiest in a terminal market where the 
operators will not have to pay the full price of purchases or 
deliver the goods when they sell, and its possibility is a 
strong argument against making speculation too easy ; it 
is possible, however, and it is done in ordinary commerce 
where there are no terminal dealings. Morally the action 
of falsifying the indicator which business follows is precisely 
the same in kind as the action of the wrecker who falsifies 
coast -lights to mislead ships; it is infinitely worse in 
degree. 

The last kind of speculation, which would seem to be 
illegitimate, is speculation that cannot have the effect, which 
legitimate speculation has, of adjusting supply to demand. 
On the produce exchanges supply, we saw, is not a fixed 
amount, but a flow that varies in volume ; by raising and 
lowering prices speculators check and encourage consump- 
tion, and in that way secure that supply shall be " averaged " 
from one period to the next, with the result that price- 
fluctuations are lessened. This action is necessary, only 
because the supply is an irregular flow ; if the supply were a 
fixed amount, there would be no need, and therefore no 
social justification, for speculation. The latter would seem 



IV SPECULATION AND INSURANCE 93 

to be the case in two important fields of speculative dealing, 
namely, Stock Exchange Securities and Land. Of course 
the floating of new companies and the issue of new shares 
to meet what is thought to be an unsatisfied need in industry 
involves risk, the same risk as attaches to starting any new 
business ; since new businesses must be started, and the 
risk is inevitable, the bearing of this risk is also inevitable, 
and a social service, and the profit obtained in the subsequent 
sale of these shares represents a payment for something 
done. But the Stock Exchange exists to facilitate, not 
the starting of new companies, but the buying and selling 
of shares in established companies, and what service to 
society is performed by the man who buys shares at one 
price and sells them at a higher price a little later it is 
difiicult to see. Dealing with shares has no influence in 
adjusting supply to demand, because the supply of shares 
of any company is a fixed amount, not an irregular flow. 
Land is similar ; so far as dealing with land can be separ- 
ated from the work of developing areas, which without that 
development would remain unused, land comes into the 
same category as shares. Its supply cannot be affected by 
changes in its price, seeing that it is not a flow, but an 
amount more or less fixed by nature. A middleman may 
perform a service by bringing together buyers and sellers 
who otherwise might have had difficulty in finding each 
other ; but speculation in land, the buying up of land in 
anticipation of a rise in its value, is of no service to society. 
This has been recognised in the United Kingdom by the 
imposition of special taxation on profits made from the sale 
of land ; the Chancellor of the Exchequer who imposed it 
might very well consider the desirability of imposing a 
similar tax on the " unearned increment " of Stock Exchange 
Securities. 



94 ECONOMICS chap. 

A v/ord may be permitted on the attitude of the State 
towards speculation on produce exchanges. Legislation is 
of little use as a check on illegitimate speculation, since it 
would be so difficult to devise a check on illegitimate 
speculation which would not act equally on the socially 
necessary speculation of legitimate dealing. The most 
practical check on illegitimate dealing lies in the difEusion 
of a feeling that the practices described above are dis- 
honourable, and the men who practise them dishonoured. 
And the chief aid to establishing such a feehng is a clear 
understanding of what kinds of speculation are necessary 
and legitimate, and what kinds are socially harmful. The 
State can help also by increasing the amount of information 
available for forming a judgment of available and future 
supplies — international action may be necessary to secure 
this end — and by making all business transactions as open 
and public as possible. Speculation on the Stock Exchange 
on the other hand could easily be stopped by any govern- 
ment that wanted to stop it. 

VI 

Insurance and other MetJiods of Meeting RisJcs 

Another method that society has evolved of meeting 
risks and minimising the inconvenience of unexpected 
happenings is the method of insurance. Whenever a risk 
is regular enough for the loss to be calculated, where the 
loss is hkely or certain to come at some time or other, it 
can be distributed over a number of years in the form of a 
small regular payment, and can be charged on the cost of 
production. It is known for instance how often on an 
average a mill is burnt down. Usually the loss involved 
would ruin the business ; but actuaries can calculate how 



IV SPECULATION AND INSURANCE 95 

mucli must be set aside each year to meet such a loss ; and 
when spread over a number of years the loss is not crushing. 
By this method of averaging risks over a number of years 
an individual can provide against ruin from the greatest 
disaster. But he would find it very expensive, and most 
risks are insured co-operatively ; a large number of indi- 
viduals contribute to a single fund from which all can be 
indemnified in case of loss. Where a large number of 
individuals pool their risks in this way (by taking out 
pohcies with the same insurance company) the contribution 
which each need make towards the insurance fund is much 
smaller than it would be if they provided agrmst the risks 
separately ; for the chances that a number of firms will, 
say, all have their mills burnt down is muv.xi smaller than 
the chance that one will. Insurance is sometimes com- 
pared with gambling ; it is, in fact, the very reverse. The 
gambler converts a certainty into an uncertainty — the 
certainty that he has his money, into the uncertainty 
whether he will have more or less in . the future. The 
insurer converts an uncertainty that he will be able to meet 
his obHgations in the event of a possible misfortune into 
the certainty that he will. But while we can insure against 
loss by Burglary, Bursting Boiler, Accident to Person, 
Property and Plate Glass, Diseases (specified or unspecified), 
Forged Transfer, Violation of Trust, as well as Fire, Death, 
and the necessity of compensating an injured employee, the 
chief risks of business are not capable of actuarial calcula- 
tion, and have to be met by the specialised instinct of the 
business man. 

The desire to abolish risk, to remove the uncertainty of 
getting a supply of materials at a uniform price, and the 
imcertainty of getting a market for products at a remunera- 
tive price, is the motive of some very important tendencies 



96 ECONOMICS cbl^p. 

in business organisation. Firms engaged in manufacturing 
are reaching forward to the consumer, and backward to 
their raw material. The big steel firms have acquired their 
own iron deposits and their own coal - pits. In this way 
they safeguard themselves from disadvantageous fluctua- 
tions in the price of their raw material. Clothing and boot- 
manufacturers are opening their own retail shops ; by so 
doing they get into direct contact with the consumers of 
their products and hope to anticipate their demands more 
accurately. Probably the desire to " steady " business, to 
prevent the recurrence of slump and boom, of under- 
production and the feverish eflort to take every advantage 
of an increase in demand, is a chief motive in those com- 
binations of competing firms which are the most striking 
feature of recent industrial history. A combination may 
secure a monopoly, but without securing monopoly, it can 
benefit its members greatly by letting them know definitely 
how much is being put on the market. Nothing is so 
disturbing to the business man's calculations as an un- 
expected " dumping " of goods on the market by a com- 
petitor. That can be stopped, if all the competitors com- 
bine to regulate the output of the whole trade. 

One other consideration must be mentioned before we 
leave this subject. Much business is routine. Our demand 
for the most important commodities — as distinct from the 
supply of produce — is stable, and can be easily anticipated. 
Where it is unstable, where it is likely to be influenced by 
fashion or whim, we are very willing to be led ; and the 
people who lead us are the people who have to anticipate 
our wants. Even when we refuse to be led, when our 
probable demand is most incalculable, the task of antici- 
pating it does not fall on every one in the trades that supply 
our wants. In each trade a few big firms, a few prominent 



IV SPECULATION AND INSUKANCE 97 

personalities, lead ; the estimation of future demand is the 
work of a few people ; the great bulk of business men are 
content to follow their lead. The big fortunes of trade are 
made by leaders, the men who foresee what is going to be 
wanted, and have it ready when it is wanted. But a large 
number of little fortunes can be made by their less enter- 
prising and less far-seeing followers who settle in the trade 
when they have opened it up, who content themselves with 
supplying, at a moderate profit, the things which are always 
vfanted, and wanted in about the same quantities. 



CHAPTEK V 

CAPITAL AND ITS ORGANISATION 
I 

Functions of Capital in Modern Industry and Commerce 

It should be obvious by this time that a society that avails 
itself of the economies of the division of labour must have 
" something in hand " ; it must have some store of saved-up 
wealth which it can use to aid it in further production. 
Wealth saved up and used for this purpose is called capital. 
Any wealth may be used as capital, provided it fulfils this 
condition — that it is used, not by the final consumer, but by 
some producer to aid him in his productive work. Capital 
has three chief functions in an economic organisation like 
the present one — (1) in the form of tools, instruments, 
" plant," it makes man's labour on Nature infinitely more 
productive than it otherwise could be ; (2) in the form of 
stocks of goods, articles ready for consumption in ware- 
houses and shops, materials awaiting manufacture, and so 
on, it enables us to adopt the roundabout and very pro- 
ductive methods of production to which specialisation leads ; 
if society was living from hand to mouth and had no savings, 
no store of wealth to aid it in further production, every 
member of society would have to occupy his whole time 
in digging and hunting for bare food ; and (3) in the same 

98 



CHAF.v CAPITAL AND ITS ORGANISATION 99 

form it enables us to take risks — to produce in anticipa- 
tion of demand instead of waiting for orders, to experiment 
with new processes, new materials, new markets, whenever 
we tMnk there is a chance of our gaining by taking the 
risk. 

Such are the uses of capital to society ; to the individual 
business -man its services are even more obvious. The 
manufacturer must have his factory, his machines, his 
power-plant ; these are all so much fixed capital. He must 
have constantly a large supply of raw and partly manu- 
factured material, which brings him nothing in until it is 
finished and sold. He needs some capital to meet the 
fluctuations of his business ; normally he may meet the 
expenses of his present manufacture with the proceeds of 
the sale of past manufacture, but the receipts may lag a 
Uttle while the expenses continue and he must have some- 
thing in hand, some working-capital, to cover this margin. 
Similarly the middleman must carry some stock ; his 
business is to have things where and when they are wanted ; 
he must therefore stock them in anticipation of demand ; 
the retailer's stock corresponds to the manufacturer's plant. 
In wholesale trade, stock is less important than formerly ; 
the telegraph, the telephone, and the railway make it less 
necessary. The merchant undertakes to supply his cus- 
tomers with anything in his Hne that they want. Though 
he has undertaken to supply it he has probably not got it ; 
the modern merchant does not buy and then sell, he more 
frequently sells and then buys. He does not buy things on 
the chance of selling them, he hkes to be sure of his market 
before he commits himself to any buying. His specialised 
knowledge consists in knowing where things are wanted, and 
where they can be got, in foreseeing how much will be wanted 
and how far the supply will go. Thus he is constantly 



100 ECONOMICS CHAP. 

undertaking to supply goods and then covering himself by 
buying ; bis constant endeavour is to be fully covered 
without having overbought. So long as he is quite success- 
ful in this endeavour, he uses his capital for such purposes 
as giving credit to customers while he has paid cash, meeting 
bad debts, and taking advantage of any offers of goods so 
cheap that they are worth taking, even though he may not 
at the moment know of any market for them. But he 
cannot be sure of being able to cover himself immediately. 
He may make a contract to supply goods at a certain price 
and then, owing to some change in the conditions of the 
market, be unable to buy them except at a higher price. 
As we have seen, it is his business to take such risks. He 
relieves his customers of some of the trouble of watching 
the market, he gives them their materials at a steadier price, 
and in return he makes them pay him rather more than he, 
specialising in watching the market, can, as a rule and on 
the whole, get them for. Obviously, however, these risks 
can be taken only by a man with some capital. 

Granted, then, the importance of capital, the questions 
arise : Who controls this capital ? What security, if any, 
have we that it is in the hands of the people who can use it 
most efiectively ? What organisation exists for collecting it 
and putting it at the disposal of the organisers of industry 
and commerce ? So essential is capital to modern business 
that these questions really amount to the same thing as an 
enquiry into the different types of business organisation, 
the dif^'erent legal forms a firm may take — an enquiry we 
have already begun in considering how the organisers of 
modern industry are appointed. 



V CAPITAL AND ITS ORGANISATION 101 

II 

Conditions Requisite for the Accumulation of Capital 

There is only one way in which either society or indi- 
viduals can accumulate capital, that is, by consuming less 
than they produce. A modern society, if it is in a healthy 
economic condition, lives well within its income ; conse- 
quently it starts each new year with a bigger supply of tools, 
machines, materials, and wealth ready for consumption 
than it did the previous year. But there is nothing inevit- 
able or automatic about this accumulation of wealth. 
Many individuals and most governments live beyond their 
income ; governments are particularly bad offenders, for, 
being unable to resist the temptation to indulge in wars 
which they cannot really afiord, they are continually throw- 
ing their liability in the form of national debts on to future 
generations ; and society only keeps up and adds to its 
supply of capital because the individual members of it, on 
the whole, spend less than they get. 

What are the conditions under which we may expect 
individuals to save, so that capital accumulates ? The 
first and essential condition is security of property. It is 
not intended by this to suggest that the existing rights of 
property must necessarily be maintained. The " rights of 
property " may vary from country to country and from 
time to time, but at any given time and country there must 
be security, or capital will not accumulate ; just as the 
worker will be an indifferent producer if employment is 
irregular and wages are uncertain. If the government 
cannot maintain law and order, or if its officers use their 
position to abuse instead of protecting its subjects, if the 
unfortunate producer is never certain how much of his 



102 ECONOMICS chap, 

product he will be able or permitted to retain, then the 
producer will produce little, and will take steps to secure 
for his own use all that he does produce, by consuming it 
all immediately. 

The second condition is that the person who saves 
should have opportunities of using his savings re- 
muneratively ; this was shown by the new openings for 
investment provided by the mechanical inventions of the 
Industrial Revolution, and by the institution of banks and 
joint-stock companies, which all stimulated the accumula- 
tion of capital. There are cases, of course, where foresight 
and imagination are so highly developed that the owner 
of wealth is indifferent whether he gets the use of it now or 
in the future ; in such cases saving is easy, and will go on 
almost irrespective of the rate of interest. But most people 
find it difficult to save ; the enjoyments that can be seciu'ed 
by spending attract, and they forget the future. Com- 
munities and classes differ in this respect as well as indi- 
viduals. It takes time for a habit of saving in a community 
to be developed. The traditional savage — happy man — 
does not worry about the future, and will not usually forgo 
a present satisfaction though he might gain thereby a much 
greater satisfaction in the future ; the French peasant, on 
the other hand, sometimes thinks so much of providing for 
his old age that he starves himself in youth and middle age. 

In the twentieth century a new consideration has to be 
added ; wealth in the richest countries is so unevenly dis- 
tributed, so much of it is concentrated in the hands of a few, 
that sometimes these few find it easier to save part of their 
income than to spend it all. The greatest fortunes are often 
made by men of uneducated tastes, who accumulate wealth, 
not for the sake of the wealth, but because their abilities He 
in the direction of accumulating wealth ; they are ambitious 



r CAPITAL AND ITS ORGANISATION 103 

only to be successfid, and among their associates success is 
measured solely by the accumulation of wealth. They do 
not know how to use the wealth they have accumulated ; 
they never realise that it needs as much ability, though of 
a different kind, to spend money well as to make it ; and 
having provided for themselves necessities and luxuries in 
excess of the most vulgar standards of ostentation, perhaps 
endowed a religious denomination or founded a university, 
they still have some of their income left and can only add 
it to their already burdensome capital. Saving with them 
is not "abstinence," but self-indulgence. Such persons 
are fortunately few, but as society gets richer, saving 
becomes possible for a larger number of people, and saving 
in larger amounts ; the accumulation of capital, unless 
interrupted by war, revolution, or misgovernment, proceeds 
like a snowball. 

Ill 

Different Types of Organisation for applying Capital 

A society's capital, however accumulated, cannot be used 
to the best advantage unless there are some means of getting 
it into the hands of the people who have organising ability. 
How far do such means exist in England to-day ? So long 
as industry was simple, so long as the tools of manufacture 
cost no more than their user could earn in a few weeks, no 
special social machinery was needed for this purpose. The 
man who had the ability to run a business could usually be 
relied on to save for himself all the capital he needed. This 
oldest of all methods of finding capital is still the most 
important. More businesses to-day are estabhshed by 
men who have saved enough to set up for themselves than 
by any other means. Most of these businesses are small, 



104 ECONOMICS chap. 

but some of them serve as stepping-stones to something 
bigger. As we have seen, there are still many fields in which 
large-scale enterprise has no overwhelming advantage over 
small. In retail trade, merchanting, and in some branches 
of the building trade, for example, it is possible for a man 
who possesses enterprise and saving habits — rather a rare 
combination — to set up without aid from other people's 
capital. Even in manufacturing, wherever it is possible 
to rent room and power, the majority of firms are often 
firms of this simple type. A man with organising ability 
and enterprise, having set up for himself, can attract atten- 
tion and find " backers." If the " backer " decides to 
come into the firm as a partner, he may bring experience 
and ability into it as well as capital ; more usually the man 
of ability but no capital gets his opportunity by being taken 
into partnership by his employer. Thus the partnership 
form removes many of the weaknesses of the private firm. 
It introduces new blood and provides more capital ; and it 
divides the work of management, which might in time be 
too much for a single man, without dividing responsibility. 
The great strength of the private firm is this union of 
interest and responsibility. The persons who have every- 
thing to gain or lose by the management of the business 
have that management entirely in their own hands. Their 
self-interest is an automatic check on waste and ineificiency. 
Moreover, centralised control saves a great deal of routine 
and red tape, and makes the business more mobile, quicker 
to act than any business managed by a committee. Hence 
it is the more suitable form of business for any enterprise 
in which risk-taking is an important element. The head of 
a private firm is likely to be more enterprising than the 
manager of a joint -stock company, because in case of 
failure he is answerable only to himself, and in case of 



V CAPITAL AND ITS ORGANISATION 105 

success he takes the whole profit ; Julius Caesar was always 
willing to risk everything on a pitched battle, because he 
was fighting for his own hand, while Pompey, with the 
Senatorial party dependent on him and " advising " him, 
dare take no risks ; the head of a business in a speculative 
trade requires very much the same qualities as a general. 

Yet industry and commerce could never have reached 
their present scale if individual action had been the only 
means of assembling and mobilising capital. Some 
businesses, such as railways and the supply of water, involve 
so large a capital outlay, and require the investor to wait so 
long for his return, that they would hardly attract indi- 
viduals acting alone, even if individuals could find the 
necessary capital. Such undertakings can best be made by 
a number of people contributing each a part of the whole 
capital, in other words by a joint-stock company. In other 
businesses, such as banking and insurance, publicity, reputa- 
tion, and size are great aids to success, and a great joint- 
stock company possesses these ; longevity is another great 
aid, and a company can outlive any individual, it need not 
be dependent on any one person and need not end with 
any one person's death. Having arisen to meet the case of 
enterprises for which it has peculiar advantages, the device 
of joint-stock enterprise has been applied continually to 
new fields of business, and new advantages have been dis- 
covered in it. This progress has been especially rapid since 
the principle of limited hability was made the basis of 
company law in 1862. So long as the shareholders in a 
joint-stock company were regarded by the law as partners 
merely, jointly and severally liable to the full extent of their 
whole resources to meet the debts of the company, this form 
of business could advance but little. The device of limiting 
hability removed the obstacle ; by complying with certain 



106 ECONOMICS chap. 

rules any company can become a limited liability company, 
i.e. the liability of each sbarebolder to meet the debts of 
the company is limited to the amount of his share ; if he 
holds only one one-pound share and the company is unable 
to meet its creditors' claims on it, he is Hable to lose his 
pound, but the creditors can claim nothing more from 
him. 

The nature of a limited liabiHty joint-stock company is 
exactly described by its name. The basis is a " joint 
stock," the capital of the company being supphed by a 
number of people who hold " shares." Usually there are 
two or three classes of shares. The "Ordinary" shares carry 
with them the control of the business, their holders take the 
profits and bear the losses ; the " Debenture " shares are 
loans of capital made to the company, on the security of 
the company's property (which can be seized if interest is 
not paid), receiving a fixed rate of interest which must be 
paid before any profits are declared, and carrying with them 
no share in the government of the company ; debenture- 
holders are creditors of the company, ordinary shareholders 
proprietors. " Preference " shares are an intermediate 
class, on which is paid not a rate of interest fluctuating with 
the earnings of the company, but a fixed rate. If the com- 
pany does well, they receive no more than the fixed rate ; 
if it does badly, the claim of the preference shares ranks 
after the claim of debentures, and must be satisfied before 
any interest may be paid ou the ordinary shares. Unlike 
debentures, however, preference shares give no prior claim 
on the property of the company. Preference shares are 
either " cumulative," in which case any deficit in one year's 
interest on them must be paid out of succeeding year's 
revenue before dividends are paid on ordinary shares ; or 
" non- cumulative," in which case the preference share- 



V CAPITAL AND ITS ORGANISATION 107 

holders' preferential claim applies to each year separately 
and is not carried forward from one year to another. 

The company form makes possible the raising of capital 
for the very biggest enterprise. It enables the holder of small 
savings, who does not wish to use them in business himself, 
and who is not in close enough touch with business to entrust 
them to any private firm, to invest his savings remunera- 
tively. It is equally useful to the holder of big savings, 
since it enables him to distribute his capital among many 
enterprises (and countries), and so avoid the risk of carrying 
all his eggs in one basket. Since shares in joint-stock 
companies are usually saleable, the investor can realise his 
property in a business without breaking the firm up ; if 
he were a partner in a private firm and wished to withdraw 
his capital, either he must find some other capitalist to take 
his place in the business by buying his share, or he must 
risk breaking up the firm, since it might be unable to con- 
tinue without his capital. The joint-stock company pro- 
vides another opening for men with organising abihty but 
no capital. As the amount of capital required to start in 
business increases, this alternative opening becomes more 
and more important; by no means, however, does it provide 
the career open to talent, which the efficient organisation 
of industry, no less than justice, requires. " Influence " 
and nepotism are by no means confined to private firms ; 
it is a great advantage to anyone employed in the higher 
branches of the railway service to be the son of a railway 
director. It is hard, however, to see how mere organisation 
can overcome this evil ; in the most democratic of countries 
we find that lucrative and influential posts in the govern- 
ment service are filled almost exclusively from the so-called 
upper and middle classes ; democracy is a spirit, not a 
piece of governmental or economic machinery. 



108 ECONOMICS chap. 

The joint-stock company has its weaknesses as well as 
its advantages. It facilitates " absentee " capitalism, a 
much greater evil than absentee landlordism. The share- 
holders of a company may profit by iniquitous conditions 
of labour or the exploitation of defenceless natives without 
even suspecting their own responsibihty ; their ignorance 
does not excuse them, but a system that permits ignorance 
is a direct discouragement to honourable dealing between 
operative and employer. From the point of view of pro- 
ductive efficiency also the joint-stock system is defective. 
The management of a business by its owner provides an 
automatic check on inefficiency and waste inside the business, 
since the owner-manager bears all loss ; the joint-stock 
system removes this automatic check. The ownership and 
control of capital are separated ; the owner takes the profits 
and the controller only his salary. Attempts are being 
made to overcome this defect by giving managers a bonus 
on profits ; but it is difficult to restore that incentive to 
enterprise, that wiUingness to act in spite of the risk of 
failure when the chances of success are great, which the 
ownership of his business gives a man. The manager of a 
company may be quite satisfied within himself that a certain 
course of action would pay, and yet be imable to explain 
or justify his belief before a committee of directors. It 
may be a case of " scrapping " good machinery on a big 
scale, or instituting a new and expensive process, or paying 
an unusually large salary to secure an unusually able sub- 
ordinate, or changing the direction of the company's aims 
to a new class of goods, requiring expensive additions to 
and adaptations of machinery, or to a new market, requiring 
a big expenditure on advertising and agents ; to the 
manager, with his vivid perception of the future advantages 
of the action, the present cost may seem almost negligible. 



V CAPITAL AND ITS ORGANISATION 109 

to the directors and shareholders the present cost — -and 
present loss of dividends — may seem so great that they 
prefer to get a new manager. Against this we must set the 
dependence of the private firm on one or two individuals ; 
how often can one see a great firm, built up by the abiUty 
of a father, go down under the incompetent management of 
his sons or grandsons. A private firm, like an autocracy, 
is an efficient form of organisation so long as its head 
is capable ; the joint -stock company, the co-operative 
society, and the municipal undertaking probably get in the 
long run as good or a better average of ability. 

It should be remembered that the convenience of limited 
liabihty is so great that many businesses which are really 
private firms, controlled and owned by one man or a single 
family, have adopted the legal form of a limited liabihty 
company. Another use of the joint-stock company is to 
enable an individual or family to increase its capital without 
relinquishing its autocratic control of the business. There are 
many large businesses, the shares of which are very largely 
in the hands of one man or one family ; all that that man 
or family has done has been to admit the public into the 
business in the capacity of sleeping partner in order to get 
additional capital. This can be done most easily if the 
family or individual on floating the business keep in their 
hands all the ordinary shares, letting the public take 
debentures. Or, again, a public company may get into the 
hands of a narrow circle of capitalists who have purchased 
a majority of the shares. 

The other important organisations of capital or types of 
business we can deal with more briefly because they are 
described elsewhere in this book. In the co-operative under- 
taking capital is supplied by the consumers who receive 
the profits, not in proportion to their holding of shares. 



110 ECONOMICS CHAP. 

like the shareholders of an ordinary company, but in pro- 
portion to their purchases. The great advantage of the 
system is the stability given to the trade of the firm by the 
dividend on purchases. State and municipal enterprise 
are similar. A municipal tramway undertaking is a joint- 
stock company in which the risks are borne, the manage- 
ment appointed, and the profits taken, by the ratepayers 
instead of by ordinary shareholders, while the capital 
embodied in the plant is suppHed by private investors, who 
receive a fi:sed rate of interest secured on the revenues of 
the municipality, and are therefore very much in the same 
position as the debenture-holders of an ordinary joint-stock 
company. The details of organisation and management in 
a municipal undertaking and in a joint-stock company are 
much the same ; the check on inefiiciency is different ; in 
the one case society relies on the shareholders and directors 
to use their power to alter the management as soon as 
inefficient management diminishes their profits, in the other 
case the ratepayers have the management in their own 
hands and are relied on to check ine£B.ciency in their own 
interests as both users and owners. The great difference 
between them, however, is a social or political, not an 
economic one ; the former is immediately under popular 
control through the machinery of representative govern- 
ment, the latter is not. 

Adam Smith has a suggestive section on the limits of 
joint-stock enterprise (Bk. v. ch. i.). 

The only trades which it seems possible for a joint-stock 
company to carry on successfully, without an exclusive privilege, 
are those of which all the operations are capable of being reduced 
to what is called a routine, or to such uniformity of method as 
admits of little or no variation. Of this kind is, first, the 
banking trade ; secondly, the trade of insurance from tire, and 
from sea risk and capture in time of war ; thirdly, the trade of 



V CAPITAL AND ITS OKGANISATION 111 

making and maintaining a navigable cut or canal ; and, fourthly, 
the similar trade of bringing water for the supply of a great city. 

The subsequent development of joint-stock enterprise does 
not prove his principle to be unsound ; it does show that 
he unduly limited the number of cases it would cover. 
The great successes of joint-stock enterprise have been in 
the field of large scale enterprise. Now large scale enter- 
prise can be conducted successfully in the long rim only if 
it reduces much of its practice to routine. Therefore to 
Adam Smith's instances we must add not only newer means 
of transport and newer developments of insurance and 
banking, but a great deal of manufacturing. Where, as 
we have suggested, a private business has a great advantage 
over both joint-stock company and municipal enterprise 
is in taking the risks of a quickly moving market. Eail- 
ways, insurance companies, tramways, water, gas, and 
electricity supplies, are not only capable of being reduced 
to routine ; they are capable of being reduced to routine 
just because they require no special marketing skill, because 
they are little troubled by foreign competition, fluctuating 
supplies of raw materials, the incursion of new firms 
into the market, and the fluctuations in demand due 
to change's in fashion and similar incalculable causes. 
Where, again, as it is so largely in the cotton industry, risk- 
taking is separated from the organisation of manufacture, 
the latter becomes a suitable field for joint-stock enterprise. 
It should.be added that a great deal of routine work, small 
shopkeeping and farming, will never be taken over by joint- 
stock enterprise because the business is not worth the 
trouble and expense of forming and registering a company. 



112 ECONOMICS CHAP. 

IV 

The Market for Capital 

Is there a market for capital ? A business requires 
capital to start it ; and it requires frequent loans of capital 
to help it carry through its commercial transactions, and 
enable it to expand. For the latter purpose there is a highly 
organised market, the so-called " Money Market " ; con- 
sideration of this must be postponed until we examine our 
monetary and credit system at length ; for the former and 
more important purpose there is no definite market, but 
the beginnings of an organised market are to be seen in the 
methods of raising capital to start a new business. The 
commonest way of collecting the capital needed for a joint- 
stock enterprise is by advertisement, and by the circulation 
of a statement of the objects and needs of the company, 
called a prospectus. There is also a highly specialised class 
of " dealers " in capital, usually called " financiers," who 
have capital of their own and also control a great deal of 
other people's capital, and can therefore ensm'e the sub- 
scription of sufficient capital to start a promising enterprise, 
can in a word " float " a business. Similarly, sohcitors, 
stockbrokers, and others, help to direct the flow of capital 
into the channel where it will give the best return. Invest- 
ment and trust companies afford perhaps the nearest 
approach to an organised market for capital ; they under- 
take to invest their capital for people who feel they have 
not sufficient knowledge to do it for themselves. Insurance 
companies accumulate enormous funds which are available 
for safe investments. And wherever an industry is strongly 
localised, its prospects and possibilities, and the prospects 
and possibilities of firms and individuals in it, are probably 



V CAPITAL AND ITS ORGANISATION 113 

sufficiently well known to make unnecessary any more 
special devices for bringing together the man with capital 
to invest and the man who can use capital. 

The Stock Exchange is sometimes spoken of as a " market 
for capital." That it is not ; the capital of a company has 
already been found and applied to the company's objects 
before its stock or shares appear in the Stock Exchange 
lists. The Stock Exchange is a market for the shares of 
companies that exist ; it facilitates the transference, not of 
capital from one industry to another, but of shares of exist- 
ing businesses from one owner to another. Indirectly, 
however, it is the means of guiding new capital into the 
industries in which it is most needed. By making shares 
readily saleable, it encourages investment ; and by register- 
ing the changes in value of shares in existing companies, it 
indicates where new capital is needed ; if railway stock 
rises in value on the Stock Exchange, people with disposable 
capital are incHned to put it into new railways ; if cycle 
shares have fallen more than shares in other industries, 
investors are warned not to put any more capital into the 
cycle industry. 



CHAPTER VI 



COMPETITION AND ASSOCIATION 



The Pervasive Influence of Competition 

Let us take our stand at the outfitter's counter once more. 
We hesitate whether to buy a woollen or a cotton shirt ; 
we might buy either, we shall not buy both. That means 
that the woollen industry competes with the cotton industry 
for our custom. We decided to buy a woollen shirt, and 
gave ten shillings for it. We could have got a cheap cotton 
shirt for 2s. 6d., and with the other 7s, 6d. bought two 
more copies of this book to present to friends. That 
means that the book trade competes with the woollen 
trade for our custom. Or we might have spent the 7s. 6d. 
on seats at a theatre ; the theatrical trade then also com- 
petes with the woollen trade. The incomes even of the 
richest are limited ; we have to choose between the different 
things that are offered to us for purchase ; therefore the 
trades supplying these things are competing for our custom. 
However, we spent our ten shillings on a woollen shirt. 
The outfitter at whose counter we stand is not the only 
man in the town who sells woollen shirts ; we might have 
gone to other shops ; tliere is competition then among 
drapers for that portion of our income which we spend 

114 



CHAP. VI COMPETITION AND ASSOCIATION 115 

upon woollen sMrts. The draper who supplied us got 
tlie shirt from a wholesale warehouseman ; he might have 
got it from some other warehouseman ; that is to say, 
wholesale warehousemen compete for the custom of our 
draper. The warehouseman bought his shirts from a 
shirt-maker ; there are many firms of shirt-makers, and 
they all compete for the warehouseman's custom. The 
shirt-maker bought the flannel, of which the shirt is made, 
from a manufacturer ; he probably does not buy all the 
flannel he uses from the same manufacturer, and flannel 
manufactm-ers compete for his custom. Similarly many 
spinners competed for the manufacturer's custom, many 
wool dealers or growers for the spinner's custom. At every 
stage in the progress of the wool from raw wool to finished 
shirt there was competition for custom. Possibly two or 
three stages in the process of manufacture were under 
the same management ; perhaps the manufacturer spun 
his own yarn, or the shirt-maker retailed his shirts to the 
public direct. But such " integration " only shuts out 
competition at one or two stages, it does not shut it out 
all along the line. A firm that controlled every process 
from the growing of the wool to the retailing of the shirt 
would still have to compete with other retailers. A trust 
that had control of the entire supply of some one article 
would have to meet the competition of substitutes and 
other commodities. In the unlikely case of a trust getting 
control of the entire supply of woollen shirts and putting 
up their price, we should buy cotton shirts ; in the im- 
possible case of a trust getting control of the supply of 
shirts of all kinds, we could still wear knitted underwear. 

We saw, however, that the woollen industry does not 
work in isolation. All the firms through whose hands 
the future shirt has passed on its way to the outfitter's 



116 ECONOMICS CHAP. 

counter employ some transport agencies. Usually they 
liave a choice of transport agencies ; that is to say, the 
various transport agencies compete for their custom. 
Possibly two or three railways competed for the privilege 
of carrying the wool from the port to the spinner ; or if 
there was no competition among railways, the railways 
had to face the possible competition of canal and motor- 
waggon. Most of the firms used some machinery ; many 
machine - makers competed for their custom. They all 
used some sort of premises ; many builders had competed 
for their custom when the premises were built. We need 
go no further back ; only remembering that steel of which 
instruments are made, and coal from which power is obtained, 
are needed all along the line, and are to be obtained fi'om 
more than one somce. 

One further step and this piece of our analysis is finished. 
At every stage in the making and moving of the shirt, 
the three agents of production — land, labour and capital — 
were used. Hence at every stage there were land-owners, 
capitalists and workers competing for employment. Each 
class competed with the other classes ; the manufacturer, 
for instance, might hesitate between capital in the form 
of labour-saving machinery and labour, between capital 
in the form of more perfect machinery and the products of 
land in the form of better raw material. And the members 
of each class compete with one another ; land-owners 
offer competing sites, labourers ofier their labour, and 
capitalists their capital against one another. 

Thus at every stage in the making of the shirt and all 
along the line there is conijietilion for custom, competing 
offers to supply. The buyer has a choice. The induce- 
ments which the sellers offer to the buyers to give them 
custom vary. The most obvious is to offer the same article 



VI COMPETITION AND ASSOCIATION 117 

at a lower price tlian competitors ; but that is not the 
only inducement. The seller may offer a better article 
at the same price ; or he may oSer the same article in a 
more attractive wrapper ; or he may advertise his article 
and so create in the buyer's mind^ without the buyer 
being conscious of it, an opinion that his article is a superior 
article ; or he may employ a persuasive agent, or a traveller 
who is a Free Mason or a Local Preacher and therefore 
acceptable to buyers who are also Masons or Local Preachers; 
or he may offer some brand or patent or speciality which 
certain users insist on having. There are many ways in 
which sellers seek to induce buyers to prefer their goods 
to those of other sellers. They may even make no attempt 
at all, and leave the buyers to decide without any induce- 
ment ; but so long as the buyers have a choice, what the 
economist means by " competition " exists ; the buyer 
is not restricted to one source of supply. 

. Competition works also the other way. Just as there 
is competition to sell, so there is usually competition to 
buy ; competition to buy is just as general as competition 
to sell. We are not the only people who want shirts, and, 
if we will not pay the outfitter's price, he will keep his 
shirt for some other customer. Our outfitter is not the 
only man who wants shirts to stock his shop, and he has 
to compete with other retailers for the stocks of the whole- 
salers. Similarly the warehousemen are dependent on the 
shirt-makers, who can play off one warehouseman against 
another. The shirt-makers compete with one another for 
the manufacturer's stock of flannel. The manufacturer 
competes with other manufacturers for yarn ; the spinners 
compete among themselves for wool. All the firms engaged 
in manufacture compete with one another for the necessary 
machines, and the machine-makers with one another for 



118 ECONOMICS CHAP. 

supplies of steel. All of them are competing for tlie use 
of transport agencies and for coal. And every firm wants 
labour, wants capital, and wants land ; and since the 
supplies of labour, capital, and land are limited, there is 
competition to buy them. 

Thus, to generalise from our humble example, a society 
which employs the division of labour is a competitive 
society, using " competition " in the broadest possible 
sense without any suggestion of good or evil. Throughout 
industry we see on the one hand competition among sellers 
for custom, and on the other hand competition among 
buyers for goods and services. 

The competition of buyers tends to keep prices up, the 
competition of sellers to send them down. Normally the 
pressure of competition among sellers is stronger than that 
among buyers. The seller has his article to sell, and must 
get rid of it ; the buyer is not yet committed to anything — 
he may decide to buy a substitute or devote his money to 
some other object altogether. But all alike are subject 
to some pressure of competition — none can afiord to forget 
that he is not alone. The seller must remember that if 
he will not sell, his customer can go elsewhere ; the buyer, 
that if he will not pay the price, there are others who may. 
Even where a single process, or the supply of some material, 
or even an entire trade, may be monopolised, the monopolist 
would not have freed himself from all pressure of competi- 
tion. He would still have to compete with other trades 
for labour and materials, with other goods for the custom 
of the public. Even the different departments of the 
same public authority compete, for example the gas com- 
mittee and electricity committee of the same municipality. 
Competition in the present economic system is like a head 
of water ; we can build our weirs and embankments and 



VI COMPETITION AND ASSOCIATION 119 

they will give us a respite from its pressure, but its force 
has not been abolished. 

II 

Conflicting and Common Interests arising from Competition 

What effect has this pressure of competition on the rela- 
tions of the firms and individuals that make up the business 
community ? We can usually trace the effect of any 
continuous pressure in the structure of a body ; we can 
do so in this case in the structure of economic society. 
Competition gives rise to a series of conflicting interests 
and a series of common interests among individual firms. 
The conflicting interests lead them to stand alone, the 
common interests lead them to associate. Thus, according 
as we look at it from the point of view of the conflicting 
or the common interests, we shall see society as an assembly 
of competing or an assembly of associated units. 

First the conflicting interests. The different trades 
compete, forward for society's income, backward for the 
agents of production and the services of the transport, 
power and implement industries. What one has, another 
cannot have. Districts and countries compete for custom — 
for the market, as we say — and for raw materials and other 
requisites of production. In each trade, at each stage, 
the different firms compete, each anxious to get as big a 
share of the whole trade as possible, each anxious to get 
its materials and the means of production specialised to 
its business as cheaply as possible. The individuals of 
society compete with one another in two capacities ; they 
compete as consumers and they compete as producers. 
As consumers they could all probably do with more than 
they get ; they would all certainly prefer to pay for their 



120 ECONOMICS chap. 

goods the lower price at wMcla they could get them if 
they were the only customers for them. Similarly they 
compete as producers ; each has some labom" to sell, or 
else the use of some land or capital. The price each can 
gets depends on the price that other people will accept 
for their labour, land and capital. Thus everywhere we 
find the conflicting interests which we commonly associate 
with the word " competition," and, because this conflict 
of interests is so obvious, we are inclined to forget or ignore 
the correlative community of interests which this conflict 
creates. 

How does competition create a community of interests ? 
It does so by its influence on prices. Competition to sell 
tends to force prices down, competition to buy tends to 
force prices up. The mere existence of an alternative 
seller is a check on the power of any seller to exact the price 
he would like ; the mere existence of an alternative buyer 
is a check on the power of any buyer to buy as cheap as 
he would like. The worker's income depends on selling 
labour at a high price and buying commodities and services 
at a low price ; it is the competition of other workers that 
keeps down the price he can get for his labour, the com- 
petition of other consumers that keeps up the price of com- 
modities and services. Similarly with land-owner and 
capitalist ; it is the competition of other land-owners and 
capitalists that hampers their eSorts to get a higher price 
for the use of their land or capital. So with industries ; 
the competition of other industries is the check on the 
prices they can charge ; at the same time it is the check 
on their power to beat down the other trades, the workers, 
the capitalists, the land-owners, fi'om whom they buy 
materials and aids to production, labour, capital and land. 
Inside any one industry, it is the competition of other 



VI COMPETITION AND ASSOCIATION 121 

firms which hampers each firm in its efforts to sell its 
products dear and to buy its labour and its materials cheap. 
The members of each economic group or class^ therefore, 
while their interests conflict within the group or class, 
have a common interest in relation to other groups or 
classes. They have a common interest in keeping up the 
selling price of the commodity or service which the group 
has to sell^ and in keeping down the buying price of the 
commodities and services which the group buys. All 
incomes depend on success in selling dear and buying cheap ; 
competition, the existence of an alternative seller or buyer, 
is the obstacle to success. The members of each economic 
group or class therefore have a common interest in extin- 
guishing or restricting competition within the group or class. 
Thus we get the common interest of all the traders in 
one district as against traders of another district ; Free 
Traders and Protectionists agree as to the desirability of 
getting as much trade for their own country as possible, 
they differ only as to the means ; and as all the citizens 
of a country have a common interest in that country's 
prosperity, so have all the members of a town or industrial 
district in the prosperity of that town or district. So too 
we get " the interest of the trade." All the persons con- 
nected with the cotton industry have a common interest 
in inducing the public to prefer cotton to woollen shirts ; 
within the boundaries of the trade they may quarrel among 
themselves as to the disposal of the price of the shirts, 
but they are united in their hostility to wool and linen ; 
they all, from the humblest operative to the biggest manu- 
facturer stand to gain by a growth in the demand for cotton 
goods. Within each trade again, while there is conflict 
between the different firms at each stage, the stages have 
each a common interest which will sometimes serve as a 



122 ECONOMICS chap. 

basis for common action. Manufactm^ers all agree that 
retailers get more than their fair share of the profits of an 
industry, and they will act together to prevent their exac- 
tions ; the retailers^ on the other hand, will form retailers' 
defence leagues to protect themselves against the exactions 
of manufacturers. All the firms at each stage of a manu- 
facturing process have a common interest in getting as 
cheap as possible what they take from the preceding stage 
and in selling their work as dear as possible to the succeeding 
stage. To come to individual firms, while employer and 
employed do not always constitute a happy family, they 
have some interests in common. The employer wants as 
big a share of the trade as possible, and his employees stand 
to gain if he succeeds. They may get no bigger wages 
than they would do if the firm were unsuccessful, but they 
gain something in regularity and security of employment. 
And when we come back to the final agents of production — 
land, labour and capital — while land-owners compete with 
one another, labourers with one another, and capitalists with 
one another, no one who is interested in politics is likely to 
forget that there is a " landed interest," a " capitalist 
interest," and a " labour interest." 

Thus everybody in our present economic society stands 
in two relations to the other members of society, in a relation 
of conflicting and in a relation of common interest. Both 
these relations spring from the same cause — the prevalence 
of what, for want of a better word, we call " competition." 
Competition tends to force us to struggle, fight, conflict 
with our neighbours ; the desire to relieve ourselves from 
the pressure of competition compels us to combine, associate, 
co-operate with our neighbours. We associate with our 
competitors in one economic group, in order to compete 
more efiectively with other gi'oups. 



COMPETITION AND ASSOCIATION 122 



III 

Combination and Trade- Unionism ; the Co-ojjerative Move- 
ment and Municipal and National Trading 

A common interest leads people to associate ; what are 
the chief forms of association in the present economic 
system ? We have seen that competition takes two forms, 
competition to sell and competition to buy. We can best 
consider the chief forms of association under these two 
heads, associations to escape the pressure of competition 
in selling and associations to escape the pressure of com- 
petition in buying. 

Associations to restrict competition in selling have 
attracted most attention, and we shall return to them 
in the next two chapters. The most important of them 
are the combinations among firms in the same trade in 
trusts, cartels, pools, and price-agreements, and the com- 
bination of workers with the same kind of skill in 
trade unions. Sellers always have acted together in fixing 
prices ; never have they competed quite freely. Such 
phrases as " the custom of the trade," a " fair price," 
" cut-throat competition," " bad for the trade," indicate 
that sellers in every trade agree informally and perhaps 
unconsciously that there are limits to their freedom of 
action, that " the trade " has a claim on their loyalty and 
consideration, because " the trade " represents an interest 
which they have in common with their competitors. Before 
the Industrial Eevolution this common interest was often 
expressed in corporate form, in gilds and companies, or 
formulated by authority in statutory prices and qualities. 
In the last generation it has again become explicit ; all 
sorts of combinations, from temporary price-agreements 



124 ECONOMICS chap. 

to complete amalgamations, have been formed. Where 
the law will enforce such a contract, contracts have 
been entered into by former competitors to observe 
common price-lists and selling rules, as has been done in 
Germany ; where the law would not enforce such a contract, 
as in England and the United States of America, secret 
agreements or out-and-out amalgamations have been sub- 
stituted. Any combination gives a respite fi'om the 
pressm'e of competition, no combination abolishes competi- 
tion. English railways are doing far more advertising 
for custom to-day, after ten years of combination and 
pooling arrangements, than they were doing before ; for 
the most successful monopolist has to compete with sub- 
stitutes, with other trades for society's income, and with 
other trades for materials and land, labour, and capital. A 
very small restriction on competition, however, may be 
sufficient to make a very large fortune. 

Trade unions are associations of sellers who, have a 
particular kind of labour to sell. Since they have usually 
nothing else to depend on, these associations are pecuharly 
important to their members, and in England are given a 
privileged legal position. They are the most obvious case 
of the stress of competition forcing people into co-operation 
or combination. Just as capitalists with a specialised kind 
of capital try to combine and get a monopoly of that kind 
of capital, so labourers with a specialised skill try to combine 
and get a monopoly of that kind of skill. In neither case, 
however, as we shall see later, does the monopoly constitute 
the only, or even the chief, advantage of combination. 
The " interest of the trade " and the " interest of labour " 
are not confined to the attempt to secure a monopoly price. 

Important as are associations to restrict competition 
in selling, they are probably less important, less successful 



VI COMPETITION AND ASSOCIATION 125 

and less general than the associations which have for 
their object the restriction of competition in hicying, or 
which are based on the common interest of the members of 
a group as buyers. Consumers^ as a class, have a common 
interest, which is responsible for many forms of association ; 
and the " competing " members of every trade have a 
common interest aa buyers, which produces much more 
stable associations than their combinations to sell. The 
one form of consumers' association which has attracted 
the attention it deserves is the co-operative movement, 
an association of consumers for the co-operative pui'chase 
of common articles. The co-operative stores of Great 
Britain have (in 1913) a membership of just under three 
million and an annual trade of over £153,000,000. The 
loyalty and continued custom of this great mass of con- 
sumers is secured by distributing among them the profits 
— or rather the difference between cost price and selling 
price — in the form of dividend in proportion to purchases. 
Idealists often lament the importance which co-operators 
attach to the " divi " — rightly, if the " divi " leads co- 
operators to forget their ideals ; but we must remember that 
the device of dividend on purchases is one of the great 
social inventions of the nineteenth century, great because 
it enlists for an idealist movement the loyal support of 
people who are susceptible only to a materialist appeal. 

The co-operative store is the best known of the associa- 
tions of consumers, but not the biggest. The friendly 
societies have a far bigger membership, and are merely 
associations of consumers to buy medical service and 
insurance against sickness. The clubs, of which English 
society in every grade is prolific, are the same in principle ; 
when Englishmen v/ish to play golf or cricket or football, 
they associate to rent and adapt fields and purchase 



126 ECONOMICS chap. 

implements ; they get billiards and cards in the same way, 
and the Christmas goose club is only another application 
of the same method. The English working-classes are 
co-operative to the backbone, if by co-operation is meant 
the association of consumers ; whatever they care most 
about, they prefer to get by associating with others to buy 
it collectively. From the point of view of economic struc- 
ture — it is not suggested that that is the most important 
point of view — the Free Churches are merely associations 
of consumers of particular " makes " of religion. 

The term co-operation is used to describe another form 
of buyers' association, which is less common in England 
and America than on the Continent. The independent 
and competing peasant farmers of Denmark require certain 
expensive machinery to turn their milk into butter. If they 
acted independently, since they could not afiord to buy 
machinery, they would have to sell their milk to a large 
firm that could, or pay some such firm a commission for 
the use of machinery, as English farmers pay for the hire 
of steam - ploughs. They prefer to act co - operatively. 
The " competitors " combine to purchase and manage the 
dairy plant, all send their milk to it, and each is credited 
with a proportion of the output corresponding to the milk 
he sends ; any profit (or loss) is distributed among the 
members in proportion to the use they make of the plant. 
The principle is exactly the same as that of the co-operative 
store, except that the members are not heads of families 
buying for their own consumption, but heads of businesses 
buying for the purposes of their businesses. Having set 
up their co-operative society, they can use it for other 
purposes, and the co-operative dairy is used to secure 
marketing facilities and for the purchase of manures, 
stock and implements. By co-operating in this way the 



VI COMPETITION AND ASSOCIATION 127 

Danish peasants have been able to compete more effectively 
with the farmers of other countries. The English farmer, 
with an industrial population at his doors, has been able 
to turn from grains to meat and from meat to milk as 
foreign competition pressed on him, and is only now finding 
it necessary to co-operate in order to compete effectively. 
Among German small farmers, the place of the co-operative 
dairy is taken by the co-operative bank. None of them 
has enough capital to work his farm to the best advantage. 
Acting independently, they would have to go to the money- 
lender and pay dear for their loans. So they combine and 
form a stock of capital by contributing each a little, and 
loan this out among the members. They are competitors 
in the sale of the product, they associate to get the means 
to raise that product. 

Less obvious applications of the same principle — the 
association of competing businesses to obtain some requisite 
of the business otherwise unobtainable, or to restrict com- 
petition in buying some requisite — are to be found in great 
industry conducted on capitalistic principles. Just as the 
trade union is an association of work-people to restrict 
competition in the sale of labour, so employers' associations 
and federations are primarily associations to restrict 
competition in the buying of labour. While employers are 
competitors in the sale of the product, they associate to 
get the means to raise that product. Their associations 
may serve other purposes, such as watching the interests 
of the trade in Parliament — an extremely important work 
in a protectionist country, where a new tariff may make 
or mar an industry — and advertising its products. Com- 
peting banks associate to maintain the clearing house, 
without which they could hardly carry on their work ; 
fire insurance companies pool their statistics, and re-insure 



128 ECONOMICS chap. 

with one another to prevent and distribute losses. Com- 
peting newspapers combine to set up press associations for 
the collecting of news, and, it is said, in one instance to 
finance the defence in a " spicy " murder case. The 
specialised market or exchange and the representation to 
the public of a localised trade's needs and claims through 
the chamber of commerce are secured in the same way 
by co-operative action. 

The parallelism of the commercial method of supplying 
a want, by independent purchase, and the co-operative 
method, by association of consumers, may be illustrated 
by a case, common in England, which embodies both 
methods — or neither. It is common for a club in England 
to be registered as a limited company with transferable 
shares which may earn a profit. If this is done merely 
for convenience of administration, and the dividend on the 
shares is limited to 4 per cent or 5 per cent, we could regard 
the club as a co-operative institution ; if, on the other 
hand, it is run primarily for profit, as many clubs are, we 
should regard it as a purely commercial undertaking in 
spite of its co-operative appearance. 

There remains for consideration an important type of 
association of consumers for co-operative purchase, namely 
the use of the machinery of representative government for 
some general economic object. Municipal and national 
trading looked at from the point of view of economic 
structure are another case of the association of consumers, 
and present a very close parallel to the two sections of the 
co-operative movement proper which have been described. 
Certain commodities of very general consumption — gas, 
water, electricity, tram service — are owned and controlled 
by the municipality. Since the municipality is simply the 
consumers in their political capacity, v,^e may say that 



VI COMPETITION AND ASSOCIATION 129 

municipal ownership is co-operative ownership. So far 
as the consumers and the rate-payers do not coincide, so 
that profits made out of the consumers and distributed in 
relief of rates are not being paid back to the consumers, 
the co-operative principle is being infringed. It should be 
noticed that these services are almost all from their technical 
nature monopolies. 

The other class of municipal trading corresponds to 
the other type of voluntary co-operative organisation, 
of which the co-operative dairy or credit bank are 
typical. It is the use of the machinery of representa- 
tive government to aid the citizens in their capacity as 
business men, not as private consumers, Bradford, the 
centre of the English woollen and worsted industry, main- 
tains a conditioning house for testing wool ; in Roubaix, 
the French woollen centre, the chief conditioning house is 
maintained by the Chamber of Commerce. The Bradford 
Corporation went for its water many miles farther than it 
otherwise need have done, because it must have soft water 
for wool-scouring and dyeing ; and it has decided to sub- 
sidise the Midland Railway Company, to induce it to bring 
its main line through the town, on the ground that a main 
through line will benefit the trade of the city. Similarly 
watering - places maintain municipal baths, municipal 
concert-halls and bands, and spend large sums on municipal 
advertising in order to aid the rate-payers in the chief 
business of the town, lodging-letting and hotel-keeping. 
So far from superseding private enterprise, these municipal 
undertakings are carried on to aid private enterprise. 
That this municipal trading is the same in principle as the 
trading of the co-operative store or Danish dairy is shown 
by the case of similar undertakings in places where the 
ordinary local authority does not represent the consumers. 

K 



130 ECONOMICS chap, ti 

Thus the Mersey Docks could not fairly be controlled 
exclusively by the Liverpool City Council, since such an 
arrangement would leave unrepresented a large number of 
users. Hence the docks are put under the control of an 
ad hoc authority, the Mersey Dock and Harboiir Board, 
representing all sections of users. Similarly the London 
Water Board and the Port of London Authority were set 
up to control public undertakings, the users of which were 
not all represented by the London County Council. 

Association, then, or co-operation, is as common in the 
present organisation of industry as is competition. The 
description of the present organisation as " the present 
competitive system " is justified by the reliance which the 
community places on competition to ensure an equitable 
distribution of wealth, and we shall consider competition 
from this point of view in a later chapter. But the common 
sharp opposition of competition and co-operation is mis- 
leading, since competition is constantly inducing members 
of the same economic group or class to associate or co- 
operate, and much co-operative organisation is for the 
object of enabling the members to compete more effectively. 
Competition and co-operation represent opposite motives ; 
but the opposite of " competitive " in the phrase " com- 
petitive system " is " bureaucratic." 



CHAPTER VII 



MONOPOLY AND COMBINATION 



In certain industries Economy and Efficiency can he 
secured only by Monopolistic Control 

In the last chapter we saw that difierent classes of buyers^ 
impelled by a common interest, formed different kinds of 
co-operative associations for buying. Similarly, we saw, the 
sellers of a commodity have a common interest in keeping 
the price of that commodity high, and this common interest 
leads them to associate or combine. Hence we get in 
modern industry cases of monopoly and a strong tendency 
in the direction of monopoly. 

An industry is said to be monopolised when the supply 
of its products or services is under the control of a single 
selling agency. This agency may be a single firm, which 
has in its own hands the entire industry ; but there may 
be many firms in the industry and yet monopoly may exist, 
provided that the firms all act together as one agent for 
purposes of selling. Monopolies fall into two classes : in 
the one class the monopoly is the outcome of technical 
considerations which make it impossible without great 
waste for more than one firm in each market to engage in 
the industry; in the other class technical considerations 

131 



132 ECONOMICS chap. 

impose no such restriction on the number of firms that can 
engage in the industry, and the monopoly is due to com- 
bination between firms which previously competed. In 
the first class monopoly is usually complete and permanent ; 
in the second it is seldom complete and seldom permanent ; 
but even when the attempt to secure monopoly fails, it 
leads to important modifications in the structure of industry. 

The chief industries that fall within the first class are 
the supply of water, gas and electricity ; tramways ; and 
postal, telegraph and telephone services. If railways may 
be taken as belonging to this type, then at least a quarter 
of the capital of the United Kingdom is invested in these 
industries. The chief characteristic of them all is that they 
are tied down by the nature of their equipment and organisa- 
tion to serving the particular market in which they are 
situated. This is so, because the products of the gas, water 
and electricity industries, and the services of the other 
industries mentioned, are distributed and delivered to the 
consumer not by the ordinary means of transport, but by 
specialised means forming an important part of the " plant " 
or fixed capital of the industry. A gas or water company 
can supply only the district served by its pipe lines, a 
tramway company only the districts reached by its tram 
lines, a telephone company only the persons connected by 
wire with its exchanges. But if these companies have 
their market restricted, they have it to themselves. Water, 
gas and electricity can be supplied cheaply only to con- 
sumers connected with the supply pipe or cable ; and, 
since it is obviously impossible to have two sets of gas 
mains, water mains and cables down every street, the fixm 
with which a consumer is connected has a monopoly of 
that consumer's custom. 

The case of the industries which maintain communica- 



VII MONOPOLY AND COMBINATION 133 

tions is similar ; tliough their monopoly is not quite so 
secure, their market is still " protected " by influences 
more potent than any tariff. Telegraph and telephone 
systems, postal service organisations, even tramway 
systems, can be duplicated at less expense than systems 
of water mains and gas mains ; but duplication impairs 
the efficiency of the service. To duplicate water mains 
would not impair the quality of the water, but a telephone 
system is efficient only when it has a monopoly. Any 
system of communication to do its work properly must 
include all the people who wish to communicate ; if the 
telephone subscribers in a district are divided between two 
competing telephone companies, then the subscribers of 
neither will have access to all the people on the telephone 
in the district. Competition between different telephone 
companies, different telegraph companies or different postal 
services serving the same area is possible only by completely 
duplicating plant and organisation, and, since the number 
of possible customers — ^the " market " for the service — 
cannot increase correspondingly, such duplication can never 
pay, and is not likely to be lasting . If it were not already 
appropriated to another purpose, the term " localised in- 
dustries " would describe this first class of monopolies. 
They can serve only the locality in which they are situated, 
and they are open to no competition from outside the 
locality ; within the locality competition is excluded, in 
the case of gas, water and electricity and tramways by the 
method of distributing the goods or services supplied, in 
the case of the communication industries by the nature 
of the service rendered. 

It will be noticed that all these industries, except the 
Post Office, require an initial expenditure of capital which 
is very large in proportion to annual working expenses. The 



134 ECONOMICS chap. 

plant in every case is expensive, but economical ; it costs 
a great deal to construct, but cheapens the service to such 
an extent that competition is possible only from firms with 
a similar plant ; the cost of supplying water, for example, 
is almost negligible, once reservoirs are constructed and 
pipe lines laid. Hence a large proportion of the income 
from fees and charges goes in payment of interest on the 
capital required for this initial expenditure ; if working 
expenses only had to be met, great reductions could be 
made in the charges made to consumers. The working 
expenses again are very largely fixed and independent of 
the number of persons served or the amount of service 
rendered. The cost of running a tram is practically the same 
whether one passenger or forty travel in it ; the driver and 
conductor must be paid, motor power supplied, track kept 
in repair and management expenses met. Hence the cost of 
production per unit of service falls rapidly as the number 
of persons served increases, while a reduction in the output 
or use of the plant brings with it a less than proportionate 
reduction in expenses or cost of production. In these 
industries, therefore, unrestricted competition means in- 
evitable ruin to the weaker competitor, and usually loss 
of all profit to the stronger. Prices or rates will be reduced 
until they are barely sufficient to cover the working expenses 
of the weaker firm and give no surplus to pay interest on 
its capital ; the stronger firm (as a rule the larger) has lower 
working expenses per unit of service and can cut prices 
still further ; as it steals its competitor's customers, its 
costs fall still further, and therefore its power to cut prices 
without actual loss is increased ; by cutting prices it ruins 
its competitor, but only at the expense of sacrificing all 
profit itself. There is not the possibility in these industries 
that there is in other industries and in agriculture of extend- 



VII MONOPOLY AND COMBINATION 135 

ing the market indefinitely by reducing prices. The market 
is limited to the population reached by the plant and 
organisation of the competing firms. Once this population 
is supplied^ prices can be cut only at the expense of the 
profits of the competitors. 

Competition, therefore, in the case of the localised services 
which we are considering, is difficult, wasteful and futile : 
difficult because it is only possible by duplicating an expen- 
sive organisation for a limited market ; wasteful, because 
the services can be supplied at their theoretically lowest 
cost only if the whole market is served by a single plant or 
organisation, and in the case of communications, because 
efficiency is secured only by one system covering the whole 
market ; futile, because the superiority of the stronger 
competitor is increased by competition, so that competi- 
tion must result in the establishment of monopoly by the 
ruin or retirement of the weaker competitors. 

II 

Railways may be classed with these Industries 

Railways may be regarded as belonging to this type^ 
It is true that competition between railways occurs and is 
not so wasteful as competition in the supply of gas, electri- 
city or tramway services. Different companies may oSer 
alternative routes between the same terminal points and 
compete for the traffic between these points ; and the 
duplication of plant which this competition involves is not 
wasteful, provided that the railways serve different districts 
en route. Still, complete efficiency requires one, and only 
one, system in each geographical area ; and if the parts 
of the system are under the control of different authorities, 
complete efficiency will be attained only by the different 



136 ECONOMICS chap. 

autliorities working together as if the whole system were 
the monopoly of a single authority. Railways are means 
of communication ; the greater the area (or population) 
to which a railway gives access, the greater is the service 
rendered. Hence in countries where the railways have 
been constructed piecemeal by different companies, clearing 
houses were early established to facilitate this inevitable 
co-operation ; the cases which have been known of compet- 
ing companies, instead of dove-tailing services, running 
trains between the same points at the same times, or arrang- 
ing their trains so that they just do not connect with those 
of another company, are merely examples of the inefficiency 
due to divided control. 

Again, competition tends to disappear. If two railways 
begin rate-cutting against each other, the struggle can 
only end, unless it is ended earlier by agreement, in 
the ruin of the weaker. The stronger competitor is the 
company that can cut rates lowest without actual loss ; by 
cutting rates it attracts traffic from its opponent to 
itself. This increase of traffic increases its margin of 
superiority, since this additional traffic does not involve 
a proportionate increase in working expenses, while the 
reduction in traffic which its opponent undergoes does 
not bring with it a proportionate reduction in expenses ; 
about 80 per cent of the expenses of a railway are fixed 
independently of the amount of traffic handled — permanent 
way and stations have to be staffed and maintained whether 
much or little traffic passes. But though the stronger com- 
petitor can be sure to ruin the weaker, it does it at the 
sacrifice of its own profits. The working expenses of a 
railway are small in proportion to its capital ; receipts 
must exceed expenses by something like a half, as a rule, 
if 3 or 4 per cent interest is to be paid on the capital embodied 



vii MONOPOLY AND COMBINATION 137 

in the railway ; a reduction on the receipts, therefore, of 
one-third will not reduce the dividend by one-third only, 
it will make it impossible to pay any dividend at all. Sup- 
pose that a railway has a capital of £10,000,000, its annual 
receipts £1,400,000, its annual expenses £800,000 ; the 
excess of income over expenses enables it to pay a dividend 
of 6 per cent on an average on its shares. Another railway 
is constructed, at a cost, say, of £10,000,000, and succeeds 
by cutting rates in attracting to itself half the available 
traffic. The expense to each railway of dealing with half 
the traffic will not be half of £800,000, it will probably be 
at least £700,000 ; the receipts of each railway will be only 
£700,000, since the two railways are now sharing the 
£l,400,000's worth of traffic which the one had before. 
The result is that each meets bare expenses and pays no 
dividend ; whereas, when one railway undertook the whole 
traffic with a capital of £10,000,000, it was able to pay 
6 per cent on that capital, now that two railways with a 
joint capital of £20,000,000 share the work, no interest is 
paid at all. Now, the users of the railways gain something 
by the reduction in rates [so long as the rate war continues) ; 
but this gain is hardly likely to balance the social loss 
involved in applying £10,000,000 new capital and increas- 
ing working expenses from £800,000 to £1,400,000 to afford 
facilities for an increase in traffic which could have been 
afforded quite as well by a slight extension of the original 
railway and a slight addition to its expenses. Hence rail- 
way history in the United Kingdom and America is a 
history of amalgamations and absorptions, and of confer- 
ences and agreements, legal or illegal, to prevent rate- 
cutting. The effect of these agreements is not necessarily 
to abolish competition, but rather to substitute for com- 
petition in rates competition in facilities ; but such agree- 



138 ECONOMICS chap. 

ments lead in many cases to a pooling of the entire traffic 
over competing lines, whicli is the abolition of competition. 
Railway systems, then, like tramway systems or water 
supplies, tend to become monopolies. They have the 
characteristics of the localised services : large initial 
expenditure on plant and organisation, working expenses 
largely independent of the number of persons served and 
amount of service given, a market restricted to the area in 
which the plant lies, and a practical monopoly of that 
market ; competition is wasteful and inefiective, unified 
management and control are required by technical considera- 
tions to secure efficiency and economy of service. 

Ill 

Methods of Social Control of these Industries 

The existence of important industries in which monopoly 
is a technical necessity introduces into the relations of the 
State to industry a complication unperceived by the early 
advocates of laissez-faire. What may be called the normal 
relation of the modern State to industry is indicated in the 
description often given to modern industry, " the present 
competitive stjstem.'" The modern State does not as a rule 
undertake to supply its members with their economic 
necessities ; it leaves this work to the free enterprise of 
private individuals. To protect its members from abuse 
under this system of tree enterprise — consumers from 
extortion and producers from under-payment — it relies 
primarily and normally on competition. It assumes that 
producers will be able to get fair payment by playing off 
one buyer against another, and that consumers will be able 
to get goods of satisfactory quality at a price somewhere 
near cost of production by playing ofE one seller against 



VII MONOPOLY AND COMBINATION 139 

another. This is the general principle ; but in the case of 
the industries we are considering the consumer is deprived 
of the protection of competition ; there is no competing 
seller to whom he can appeal, if the first he applies to sup- 
plies an inferior article or charges an unfair price. The 
State, therefore, is faced with a new problem : if it continue 
to rely on and to foster competition it encourages waste and 
inefficiency, and leaves the consumer at the mercy of the 
monopolist ; if it departs from its usual principle it has to 
discover some other method of controlling industry in the 
interests of the consumer. In the United Kingdom and 
on the continent of Europe the necessity of monopoly, 
coupled with some special form of control, has usually been 
accepted, differences have arisen only as to the form which 
control is to take ; in America there has been a much greater 
reluctance to depart from the principle of free enterprise, 
and attempts have constantly been made to stimulate and 
support competition. The influence of technical considera- 
tions, however, in promoting monopoly, and still more the 
fact that competition is self -destructive, have proved too 
strong for such attempts, and even in the United States 
the policy of granting unlimited and unconditional " fran- 
chises " to gas, water and tramway companies is coming to 
an end. 

These industries all involve a considerable disturbance 
of private property in the construction of their equipment ; 
to acquire the compulsory powers, which such disturbance 
needs, they have to apply to the State ; this application 
gives the State the opportunity of imposing conditions and 
exercising control. The permission to engage in any of 
these industries is usually embodied in a private Act of the 
Legislature or a " concession " or " franchise " from a local 
government authority. The State assumes that the mono- 



140 ECONOMICS chap. 

poly is its property when it grants the company permission 
to engage in the industry. The grant transform.s a tendency 
into a fact ; technical considerations gave the industry a 
tendency in the direction of monopoly, the intervention of 
the State gives the monopoly legal sanction. With the 
grant are coupled the conditions which have for their object 
the protection of the consumer. 

The simplest form of control is for the State to limit 
the rate of profit. The rate of interest which the company 
may pay on its share capital is fixed ; any excess of 
earnings above that figure goes to the State (as in the 
case of certain French railways) or to the consumers in 
the form of reduced charges (as in the case of certain 
English gas companies). This method of control has two 
great defects ; the rate of profit depends not on charges, 
but on capitalisation on the one hand, and on efficiency 
of management on the other. It is possible for the 
concessionaires, by capitalising the company at a high 
enough figure, to pocket the whole value of the monopoly 
in a lump sum, after which excessive charges will only 
pay a moderate rate of dividend. On the other hand, 
efficient management may by preventing waste and im- 
proving organisation earn sufficient profit to pay a high 
rate of interest on a moderate capitalisation without 
excessive charges ; in which case to limit the rate of profit 
is to penalise efficient management without in any way 
benefiting the consumer. Instead of limiting the rat« of 
profit the State may limit the charges which the company 
may make. The charges which English railways may 
make are limited by the Acts of Parliament constituting 
them ; and eince 1894 they have been allowed to raise 
rates only with the permission of a special court, the Rail- 
way and Canal Commission. This method of control is 



VII MONOPOLY AND COMBINATION 141 

more effective than tlie last ; tlie control is applied at the 
point at which the public is likely to suffer and the method 
is simple. Simplicity, however, has its disadvantages. The 
fixing of prices is the most difficult part of business, even 
in railways, and the setting of maximum rates by a State 
authority is an illogical compromise between making the 
State responsible and making the company responsible 
for the rates. If the maxima set by the State are high, 
they are no protection to the consumer, since the company 
would, if left to itself, be deterred from raising rates to 
such a height by the fear of losing traffic ; if the maxima 
are low, then the company's freedom to fix its own rates 
within the limits of the maxima is illusory. Maxima tend 
to become minima ; if the companies are not to be allowed 
to raise a rate which proves unremunerative they will not 
experiment in lowering rates in the hope of attracting 
additional custom ; which may be one reason why English 
railway rates, which fell quite steadily so long as the 
companies were free to raise them, have stopped falling 
since 1894, when the power to raise them freely was taken 
away. In the case of railways, at any rate, if the State is 
going to interfere with rates at all, it had better undertake 
the fixing of them altogether ; and if it undertakes the 
fixing of rates, which is the most difficult part of railway 
administration, it will be forced in the long run to under- 
take the entire management of the railways. 

Another compromise between private enterprise and 
public control is the system under which the State con- 
structs and owns the plant, but leases it to a company to 
operate ; French railways and English tramways in most 
cases were originally under this system. The advantages 
claimed for the system are that it gives complete control 
without withdrawing the stimulus to enterprise and efficiency 



142 ECONOMICS chap. 

afforded by profit. The State can exact the full value of 
the monopoly as the price of the lease or in the form of 
rent ; it can insert among the conditions of the lease any 
limits on rates and charges which seem desirable ; it is 
relieved by the company of the task of dealing with large 
bodies of employees^ a task for which it is contended that 
a representative authority, dependent on popular election, 
is unsuited, and the automatic check, which working for 
profit imposes on waste and inefiiciency, is left unimpaired. 
Certain corresponding disadvantages are urged by those 
who advocate State operation as well as ownership of these 
services. The control is not complete and may be in- 
effective to protect the public ; if rates and charges are 
fixed, the company can vary the quality of the service ; 
the desire to make the most of the monopoly while the 
lease lasts is one incentive to extortion, the knowledge 
that the whole business must fall into the hands of the 
State on the termination of the lease is a check on enter- 
prise and the investment of new capital. The slow develop- 
ment of electric tramways in England, a generation behind 
the United States, is usually put down to the fact that the 
tramway companies were liable to be superseded by the 
municipalities. 

Finally, the State can both own and operate these services, 
as it does in the case of posts and telegraphs everywhere, 
railways on the Continent, and an increasing number of 
gas, electricity, water and tramway services in both Europe 
and America. This tendency has been opposed on the 
grounds usually taken against anything socialistic. By 
removing profits it is alleged you remove the chief check 
on waste and the chief incentive to efficiency. The best 
economic and political areas do not necessarily coincide ; 
a population of 100,000 may be quite large enough for a 



VII MONOPOLY AND COMBINATION 113 

separate municipal government, but is much too small for 
a separate electricity supply. Public management of these 
services, it is alleged, will result either in a bureaucracy as 
unaccountable to public control as any private employer, 
or in management by politicians who will be guided in 
their decisions not by technical knowledge, but by the 
agitation of voters as ignorant of technical considerations 
as themselves. In reply to such objections it is urged that 
it is only by supplying these services itself that the State 
can be sure of securing the profits of monopoly and pro- 
tecting the public against extortion. The interest of the 
consumers, who can influence the management through 
their votes, is as powerful an incentive to efficiency as is 
the desire for profits under private enterprise. Each party 
to the controversy contends that in practice the method 
of management which it advocates shows the greatest 
efficiency and economy. 

While the controversy continues, the tendency is for 
these monopolistic industries to be taken over more and 
more by the State. Moreover, the tendency is older than 
the controversy ; a large number of municipal gas under- 
takings in England, for example, had been municipalised 
before any of the existing socialistic organisations had been 
founded. The tendency is the outcome of practical con- 
siderations, influencing city councillors and administrators 
who were uninterested in theoretical discussions on the 
province of the State. The services are all essential services, 
so essential that public control is of greater public import- 
ance than lowness of cost. The management of them is, 
compared with the management of any export industry, 
simple, since the market risks involved are so slight ; foreign 
competition is impossible, the demand is steady and easily 
calculated, all the consumers are on the spot. Heiice as 



144 ECONOMICS chap. 

the State extended its functions, these industries were 
naturally the first it would undertake. The industries are 
not only local in their services, but within their locality 
they serve a very large proportion of the population. 
Every one needs water, gas or electricity, a postal service, 
trams and railways ; hence public management of these 
services, means management by the consumers through 
their representatives, and these State and Municipal 
industries are merely a special case of the co-operative 
movement which we examined in the last chapter. In 
the case of the railways of continental Europe another 
consideration enters in. The States have all long land 
fi-ontiers ; the railways are therefore an integral part of 
the system of national defence. The governments wished 
the railway systems to conform to strategic as much as to 
economic requirements, and to secure this end they have 
undertaken a greater share in the construction and control 
of them than the governments of the United Kingdom and 
America had any need to do. 

The question as to efficiency of management cannot 
be decided in the abstract, and is a political rather than 
an economic question. It is a waste of time to discuss 
what the State can or should do in the economic field as 
if the State were always and everywhere the same thing. 
" The State " is one thing in Prussia where there is a 
long tradition of administrative efficiency, another in the 
United States where the " spoils system " has not on 
the whole encouraged self-sacrifice and devotion in public 
officials, and where the tradition of laissez-faire is much 
stronger. " Municipal enterprise " means one thing in 
industrial England, where business men rule the muni- 
cipalities, and give to the public service frequently the 
same care and ability that they give to their own 



VII MONOPOLY AND COMBINATION 145 

businesses, simply because business management is the 
chief interest of their lives ; it means another in London 
and the South, where local government authorities are 
more under the influence of landowners and professional 
men. Efficiency in these services depends more than on 
any other consideration on the appointment of the best 
men to the positions of direction and management ; there 
is nothing in the nature of representative government itself 
to make one think that a municipal committee or State 
department will be more efficient or less efficient than the 
directorate of a joint-stock company, that officials appointed 
by the one will be more efficient or less efficient than officials 
appointed by the other. In both cases jobbery and in- 
fluence are possible ; and while corruption is a greater evil 
in the public service than in private trading, a comparison 
of governments in different countries, or in different areas 
of the same country, does not suggest that there is least 
corruption where the government restricts its activities 
most, but rather the reverse. The limits within which 
" the State " can undertake economic services are set not 
solely by economic considerations, but at least as much 
by the public spirit and social traditions of the citizens. 



CHAPTER VIII 

MONOPOLY AND COMBINATION (continued) 

I 

The Te7idency to Monopolistic Combination 

The tendency to monopoly is not confined to industries in 
which technical economy requires monopoly ; it is fo-und 
in many branches of industry where technical considera- 
tions do not necessitate it, and the motives which lead 
competitors to combine and eliminate competition are 
found in every field of economic activity. Competition 
among sellers tends to force prices down, the interest of 
sellers lies usually in keeping prices up ; this is usually 
the first motive inducing producers to combine. Competi- 
tion, again, introduces new risks and accentuates the risks 
inherent in a system of production in anticipation of 
demand. In a competitive industry every producer has 
to estimate not only the total demand for his product, but 
also the amount that his competitors intend to produce 
and the proportion of that total demand which he will be 
able to supply ; a monopolist, controlling and therefore 
knowing exactly the supply, would have to estimate only 
the demand, and would run little risk of " spoiling the 
market " by glutting it. Competition diminishes profits 
in another way. We speak of the market for any product, 

146 



cHAP.vni MONOPOLY AND COMBINATION 147 

as if competition were always active tlirougliout the area 
and between all the sellers of the product. In practice 
such a market is made up of a large number of smaller 
markets determined by locality, interest, custom ; every 
firm has its own " market," consisting of a number of 
customers who normally can be relied on to deal with that 
firm ; their custom constitutes the firm's " goodwill." 
When trade is bad, however, the barriers between these 
subordinate markets are broken down, local markets are 
invaded by the products of firms at a distance, " goodwill " 
goes for nothing. The desire to prevent this invasion of 
their market, to secure their market and a steady trade 
by depriving their customers of any alternative source of 
supply, is a chief motive of combination, patents, brands, 
trade-marks and all other forms of monopoly. 

Monopolistic combinations have been classified by Mr. 
Macrosty in accordance with their relative permanence. 
The lowest form of combination is the temporary combina- 
tion of dealers to get control of the supply of a product 
for a limited period and force prices up. Such operations 
on produce exchanges are called " Corners," and are tempt- 
ing to speculators on those markets in spite of the risk of 
failure, first, because they can get control of the produce 
coming into the market by paying " differences " only, not 
the entire price of the produce, and, secondly, because the 
other dealers on the market, having sold for future delivery 
without foreseeing the " corner," will be forced to buy at 
the monopolist's price, or fail to meet their obligations ; 
they cannot wait for prices to come down. 

Next in order come informal agreements among dealers 
to observe a price - list. Such agreements, constantly 
broken and constantly renewed, until they acquire a sort 
of sanction in the " custom of the trade," have always 



148 ECONOMICS CHAP. 

existed, especially among retailers, and, in the opinion of 
Mr. J. A. Hobson in 1906/ extracted more from the con- 
sumer in the way of excessive prices than all the trusts 
and industrial combinations put together. Such agree- 
ments have given way in many cases to formal associations, 
with constitutions and officials to fix prices and regulate 
terms of sale. The weakness of these associations is that 
by raising prices they encourage their members to increase 
their output. The market will not take the increased out- 
put at the old price, and the temptation to secure the large 
profits, which must accompany the increased sales of the 
first firm to break the agreement and cut prices, is usually 
too strong to resist. Hence price-agreements often develop 
into agreements to control output as well as to maintain 
prices ; and these in turn, since the temptation to secure 
additional trade by cutting prices below the agreed list is 
still in some cases too strong, give way to arrangements by 
which the entire trade is pooled and the receipts shared 
in certain fixed proportions. In England and the United 
States agreements of this nature, however comprehensive, 
are always insecure, because they cannot be enforced at law. 
The Common Law regards agreements in restraint of trade 
as contrary to public policy ; consequently, if one of the 
parties to an agreement of this nature breaks it, the other 
parties cannot sue him for breach of contract or force him 
to pay any penalty which the rules of the association may 
impose. 

Hence the price-agreement or " pool " does not con- 
stitute a complete fusion of interests ; there is always 
a strain on the loyalty of some, especially the stronger, 
of the parties to it. When trade is good, all can do without 
the association ; wHen trade is bad, it may always pay 
1 Evolution of Modern Capitalism, p. 191. 



viii MONOPOLY AND COMBINATION 149 

the stronger members to break away, and, by cutting prices, 
capture their competitors' market. Profits depend on out- 
put or turnover quite as much as, if not more than, they 
do on prices. Hence the leaders of industries, who desired 
to effect a complete fusion of interests, have been forced 
in the United States to amalgamate the competing firms 
into one, and form what is usually called a " trust." The 
term " trust " was originally applied to a device for fusing 
interests without complete amalgamation ; a joint-stock 
company was formed which acquired, usually in exchange 
for its own stock, a bare majority of the shares of each of 
the competing firms in the industry ; a bare majority of 
shares in a joint-stock company gives complete control of 
the company ; hence the central company, the " trust " 
proper, could control all the firms in the trade. But this 
device was declared illegal as being in restraint of trade, 
and the complete amalgamation took its place. Amalgama- 
tion may be effected by an exchange of shares between the 
combining companies ; but usually a new joint-stock 
company is floated and buys the separate firms. 

In Germany the Common Law rule is different, and agree- 
ments to regulate prices can be enforced in the courts. 
This difference has made possible federations as permanent 
and secure as the complete amalgamations of the United 
Kingdom and America. In the cartel, the typical German 
combination, the competing firms combine to establish a 
single selling agency. They agree with one another by a 
legal contract to sell to this central selling agency alone, 
and the agency undertakes to take their whole output ; 
in the same contract the proportion of the entire output 
which each firm may produce is settled. By this arrange- 
ment the single agency acquires control of the product of 
the whole industry, and can vary prices — and, with the 



150 ECONOMICS chap. 

consent of the members, output — to secure tlie greatest 
possible net profit. At the same time the firms retain their 
independence for purposes of internal management. Thus 
the cartel retains separate management of production 
while securing unified management of selling. 

After allowing for all the difficulties of successfully 
working a monopoly, it is surprising that there are not 
more industrial monopolies ; but combinations, though 
attractive, are not easy to form. The first obstacle to 
their formation is the difficulty of bringing together to a 
common agreement a number of firms that have known 
one another previously only as competitors ; the feeling of 
hostility and emulation persists even when the loss and 
worry involved in fighting have been recognised. This 
feeling is reinforced in the case of many private firms by 
a pride in, and attachment to, their independence, which 
they are unwilling to sacrifice even on advantageous 
economic terms. The inequality in competing strength 
of the separate firms in most industries is another obstacle ; 
the strong firms can get along very well without the aid 
of a combination, while a combination that did not include 
them would be unable to control the market. A period 
of bad trade, following on and contrasting with a period 
of good trade, is usually needed to produce the state of 
mind in which projects of combination are generally wel- 
comed ; when trade is good, every efficient firm can get 
its prices without the aid of combination, the scramble 
for orders on a declining market is needed to remind pro- 
ducers of the folly (from their point of view) of competition. 
The mere task of negotiating a combination — inducing 
competitors to meet, adjusting conflicting interests, allow- 
ing for " goodwill," and settling tho terms generally on 
which the separate businesses are to be taken over — is 



VIII MONOPOLY AND COMBINATION 151 

formidable J and calls for a high degree of diplomatic skill 
and business statesmanship. 

For these among other reasons few industrial combina- 
tions that have been formed have been inclusive of the 
whole trade. Some firms in the market have stood out^ or, 
if the combination was originally inclusive, new firms have 
come into the market. If only a small proportion of the 
trade, however, is outside the combination, its influence 
over prices will not be seriously impaired ; a combination 
with 70 per cent of the trade in a market is in practically 
as strong a position as one with 100 per cent ; the latter's 
control of prices is usually as strictly limited by potential 
competition. A more serious outcome of the difficulties 
attending the formation of combinations is that they are 
nearly always over-capitalised, and this in two ways : the 
actual capital engaged in the industry may be greater than 
is needed to satisfy the normal demand of the market at a 
remunerative price ; and the nominal capital on which 
dividends are paid, if any profits are earned, may be so 
much greater that dividends become the exception rather 
than the rule. A trust is formed at the end of a boom ; 
during the boom old firms have expanded and new firms 
have been established, with the result that when trade 
becomes normal, the product which the industry can put 
on the market is far greater than the market will take at 
a price high enough to repay the cost of production ; yet 
the whole of this producing capacity has to be brought into 
the combination, or the object of the combination, monopoly, 
will not be achieved. When the United States Steel Cor- 
poration was formed it had a producing capacity more than 
half as gi'eat again as the normal output of the United States 
heavy steel industry, yet it did not include the whole trade. 
The organisers of a trust, to secure a monopoly, have to 



152 ECONOMICS chap. 

induce all or most of the firms in the industry to come into 
the combination ; this is known^ and the knowledge induces 
firms to stand out for a higher and a higher price as the 
number of outstanding firms decreases ; it is said that the 
largest of the firms which were combined in the United 
State Steel Corporation was able to insist on a price 50 
per cent higher, on the same valuation as the other firms, 
and to secure payment exclusively in debentures. Hence 
the public, in being asked to take up the shares of the 
new trust, are being asked to pay a price for the industry 
as a going concern often far higher than is justified by the 
earnings of the industry even in a trade boom. In addition, 
the profits which are expected from monopoly are often 
capitalised and added to the price at which the investing 
public is asked to purchase the industry, while no allow- 
ance is made for the reduction in output which will be 
necessary to keep prices up and for the disuse of plants 
which have only been bought up to extinguish competition. 
Indeed a principal motive of the promoters of trusts is the 
profits which they can make at the expense of the investing 
public ; the motives of the investors in submitting to be 
fleeced are more difficult to understand. In the case of 
cartels, where the only new company formed is the selling 
agency, which has usually a nominal capital held exclusively 
by the constituent firms, the corresponding difficulty lies 
in determining the total output and the participation in it 
to be allotted to the different firms. To allow every firm 
to produce to its utmost capacity would flood the market 
and make it impossible to keep prices up ; yet the stronger 
firms will not join the cartel if they are to be prevented 
from taking advantage of their strength. Hence the 
cartel is often committed at the outset to an amount of 
production so great that it has to offer bounties on export 



vm MONOPOLY AND COMBINATION 153 

to its constituent firms^ to induce them to send some of 
their output into foreign markets ; just as the American 
trust practises " dumping " abroad in order to keep up 
prices in the protected home market. 

II 

Conditions favourable to Monopolistic Combination 

The formation of a combination is facilitated if the 
industry is localised. If the firms to be combined are 
situated close together, their heads will frequently meet, 
will know one another and one another's circumstances, 
and be predisposed to combine. Probably joint action to 
restrict the severity of competition will have taken place 
before the proposal to elimipate competition by combina- 
tion is mooted. Bonds between the separate firms will 
already exist in the local trade associations for marketing, 
securing technical efficiency and dealing with labour. The 
importance of this influence is illustrated by the difficulty 
of forming, and still more of maintaining, international 
combinations and agreements ; they may be expected to 
come, but at present their stability is as inferior to that of 
national and local combinations as are international alliances 
and inter-state law to national associations and state law. 

While the influence of locality is important, however, 
the condition that most favours monopolistic combination 
is some natural or social limitation on the number of firms 
engaged in an industry. When an industry can be carried 
on only on a large scale and with large capital, it is difficult 
for new firms to enter it, and the way is made open for com- 
bination among the firms in it. For this reason the heavy 
steel industry has proved a favourable field for combina- 
tion, and the companies carrying on liner traffic, few of 



154 ECONOMICS chap. 

wliic]i in England have a capital of less than half a million 
pounds, are all ii; rings or conferences. Any kind of 
natural scarcity in an industrial material favours combina- 
tion ; the anthracite coal industry is controlled by close 
combinations both in England and America, and the 
petroleum industry has the most famous of trusts. Climate 
may have this effect ; one of the most successful English 
trusts is the Fine Cotton Spinners' and Doublers' Associa- 
tion, which carries on a trade restricted by climate and 
skill to a small area in Lancashire. Soft water for bleaching 
and dyeing, and a prescriptive right to turn an objectionable 
effluent into streams, have been of influence in the formation 
of combinations. Even more favom*able to concentration 
is some previously existing element of monopoly, such as 
that afforded by the possession of patent processes, dis- 
tinctive brands and trade-marks ; the chemical and aniline 
dye industries are concentrated on the basis of patents, the 
tobacco and snuS industries on their brands, the American 
chewing-gum industry and English cocoa industry on their 
flavours. The State may limit entry into a trade ; when it 
does so, it encourages combination ; the beer trade and 
railway industry are examples. The control of one mono- 
polistic industry naturally limited may be used as a means 
of securing monopoly in another ; control of railways was 
the means by which the Standard Oil Trust was formed, 
and is the basis of the Chicago Beef Trust. 

One influence favouring trusts requires special treat- 
ment, since it is often put forward as the only cause of 
combinations, namely, the influence of a protective tariff. 
That it is not the only influence is shown by the fact that 
monopolistic combinations exist and are growing in the 
United Kingdom under Free Trade ; that it is a condition 
favourable to combination is suggested by the greater 



VIII MONOPOLY AND COMBINATION 155 

development of tlie combination movement in the United 
States and Germany. A protective tari-ff seems to encourage 
and to facilitate combination. The way in which it en- 
courages combination is illustrated by the history of the 
Sugar and Whisky Trusts in the United States. The high 
protection afiorded to these industries encoviraged such a 
rush of capital into them that competition within the pro- 
tected market became much keener than competition out- 
side ; excessive competition led to price-cutting and loss 
all round, and encouraged the competing firms to combine 
as the only means of avoiding bankruptcy. How excessive 
was the over-production produced by the bait of a protected 
market is indicated by almost the first action of the two 
trusts formed ; the Whisky Trust closed down sixty-eight 
of the eighty distilleries it took over, the Sugar Trust 
seventeen of its twenty - three refineries. A protective 
tarifi facilitates combination, since it offers competing firms 
freedom from foreign competition, and therefore a monopoly 
of the home market, if only they can agree to extinguish 
competition among themselves. The control of a national 
market is much more of a " business proposition " than 
the control of a world market. Certainly the first thing 
a protectionist government wiU do, if it is seriously opposed 
to the trust movement, will be to lower or abolish its tariff. 
Trusts not only owe much to tariffs, but react on them by 
enormously strengthening the interests opposed to the 
reduction or repeal of protective duties. 

Ill 

Difficulties of Monopolistic Combinations 

The troubles of the would-be monopolist are not ended 
when his combination is formed. If the monopoly is an. 



156 ECONOMICS chap. 

amalgamation and over-capitalised^ ordinary good manage- 
ment is not sufficient to produce dividends ; if it is a pool 
or cartel, there will be constant quarrels over the pro- 
portions in which the trade is distributed among the con- 
stituent firms, and big firms will upset the equilibrium of 
the organisation by buying up smaller firms and absorbing 
their rights in the trade. No monopoly again, however 
complete, is unafiected by the general fluctuations of trade. 
In times of declining trade the German cartels have been 
forced to adopt the expensive device of paying bonuses on 
export in order to keep up prices m the home market, the 
only market where their monopoly is effective ; the American 
trust meets the same difficulty by the practice of " dump- 
ing " a portion of its output abroad at any price. When we 
were studying the relative advantages of large and small 
scale enterprise, we found that one of the difficulties of the 
large concern was that the difficulty of management was 
out of all proportion greater in the case of the large concern. 
Similarly the concentration of the management of a whole 
industry into a few hands is economical, as will be seen in 
a moment, provided that the few hands are equal to the 
task ; at the same time there is a risk involved, the risk 
of putting all the eggs into one basket, and several incidents 
in the history of the trust movement emphasise this risk. 
The great Steel Trust was formed, it has been said, to 
remove Mr. Carnegie fi-om the industry before he had 
absorbed the whole of it ; having acliieved their object 
and removed Mr. Carnegie, the promoters were unable to 
find any one who could do the work which Mr. Carnegie 
had been doing ; men who can organise from one centre 
the whole of a great industry are difficult to find. The 
mammoth business in competitive industry is usually based 
on exceptional ability, and industrial combination is no 



VIII MONOPOLY AND COMBINATION 157 

adequate substitute for such ability. During the ten years 
that the United Alkali Company was paying no dividends^ 
the firm of Brunner^ Mond & Co. was growing bigger and 
more profitable every year ; for the four years, 1902-1905, 
while the English Sewing Cotton Company paid no dividends, 
Messrs. J. & P. Coats, an amalgamation of four firms 
only, but those the four strongest, paid 20 per cent ; for 
the years 1901-1905 the British Cotton and Wool Dyers 
paid no dividend, the Bradford Dyers' Association paid a 
steady 7 per cent. 

The power of the trust over prices is limited not only 
by the general movements of trade, but by two less 
obvious but even more important influences, the com- 
petition of substitutes, and potential competition. Just 
as a railway plying between two ports has to limit its 
rates to the figure at which goods can be sent by water, plus 
an allowance for the greater convenience and speed of 
railway transport, so an oil trust must not raise its prices 
to the point at which it pays consumers to install gas or 
electricity, or to revert to candles. The United Alkali 
Company was formed to include all the firms using the Le 
Blanc process of making alkali and bleaching powder ; the 
effect was to stimulate invention, until the electrolytic 
method of making bleaching powder, already known in the 
laboratory, was made commercially profitable. The French 
Copper Syndicate of 1888 foundered on the same rock, the 
competition of substitutes. The other influence, the danger 
of stimulating competition where it does not already exist, 
is naturally more difficult to illustrate ;' just as the possibility 
which exists under the English constitution of creating new 
peers converted the House of Lords' Veto from an absolute 
to a suspensory veto, although the power has not actually 
been exercised for two hundred years, so the possibility of 



158 ECONOMICS chap. 

attracting competition converts a monopolist's control 
over prices from an absolute control to fix them where lie 
will to the more limited power of delaying a fall and speed- 
ing up a rise ; the example of the Steel Trust, howe-ver, is 
suflB.cient to indicate what is possible. The trust began 
its career with 80 per cent of the heavy steel trade of the 
United States ; its capacity was great enough to produce 
nearly 60 per cent more than the greatest actual annual 
output hitherto reached in the United States ; at the end 
of eight years, though its productive capacity had increased, 
its share of the trade had sunk to 50 per cent. The case is 
the more significant, since it occurred in an industry in which 
a large capital is needed to establish a new firm and the 
trade risks are great. A monopolist, by raising prices or 
doing anything else to suggest that he is earning exceptional 
profits, tempts other capitalists to enter the industry ; and 
it should be noted that they are tempted not only by the 
prospect of sharing the profits if the prices remain high, 
but also by the alternative hope that the monopolist will 
be induced to buy them out on their own terms, if the 
competition forces prices down. 

IV 

Advantages of Monopolistic Combination 

It has been necessary to give some space to explaining 
the obstacles in the way of establishing monopoly in com- 
petitive industry, because it is at fixst sight surprising that 
the trust movement has not developed further than it has, 
and that its history is strewn with so many failures. In 
spite of failures, however, the development of the move- 
ment proceeds ; apparently we may expect the " combine " 
of firms to become as normal in the twentieth century as 



vrii MONOPOLY AND COMBINATION 159 

the large firm has become in the nineteenth ; for, while 
the chief motive of combination is the desire for monopoly, 
and complete monopoly is rarely achieved, the result of 
combination is a possibility of economies so great that 
complete monopoly becomes unnecessary for high profits. 
That it is by economies rather than monopoly that great 
profits are made is suggested by the success of those " trusts," 
like Messrs. J. & P, Coats, which were formed by the amal- 
gamation of a small number of strong firms without any 
attempt to comprehend the whole trade, and of those great 
firms, such as the Carnegie Steel Works and Messrs. Brunner, 
Mond & Co., which have grown from small beginnings with- 
out any attempt to secure monopoly, and have come nearer 
to monopoly than most combinations which set out with 
monopoly as their object. 

What then are the special economies within the reach 
of these trusts ? They are simply an extension of the 
economies of large-scale production, and very similar to 
the economies of localised industry. Just as the large firm 
can specialise departments, the trust can specialise firms. 
If it is a combination in a localised industry, some such 
specialisation will have arisen already, and the trust will 
merely arrange that the firm with a speciality shall devote 
its whole resources to that speciality. The trust is able 
to carry the specialisation of labour further and to retain 
more highly specialised skill ; its ability to retain the best 
legal skill has been frequently illustrated. With its central 
control of the industry it can develop resources, such as 
the pipe-lines of the Standard Oil Trust, which no smaller 
corporation could finance. Many trusts have taken steps 
to secure the sources of their raw material. Along with the 
economies of greater specialisation goes a saving in general 
expenses. To sell its goods, a firm in a competitive market 



160 ECONOMICS chap. 

has to maintain a system of travellers^ agents^ advertise- 
ments^ which is constantly growing in expense. One firm, 
to give it a competitive advantage over the other firms, 
adopts some new advertising device ; all the other firms 
are forced in self-defence to follow suit ; the result is that 
none gains any advantage over the rest ; they are as they 
were, but the expense of the advertising device has been 
added to the normal costs of the trade. A trust can reduce 
this kind of expenditure, or at least stop its growth. One 
set of travellers can now take out the samples of as many 
firms as there are in the combination ; the trust, if it 
advertises (as it usually must), can regulate its expenditure 
on advertising itself, instead of having expenditure con- 
stantly forced upon it by competitors. The centralisation 
of purchases and sales may allow of saving, certainly the 
centralisation of finance and insurance should be an economy. 
Above all, it is a great economy to know, instead of having 
to guess, how much of their product is going to be put on 
th,e market ; nothing is so conducive to cheap production 
as a steady output, no obstacle to a steady output is so 
great as the action of a large number of producers acting 
independently, each endeavouring to steal the other's trade 
and uncertain what proportion of the aggregate demand 
of the market he can safely offer to supply. A minor 
economy arising from central control is the saving of trans- 
port charges in the form of cross freights, by supplying 
customers from the nearest plant. 

All these are social as well as private economies, since 
they mean an equal output for a less expenditm-e. The 
combination, however, has certain advantages over the in- 
dependent firm in securing trade and controlling prices, 
certain competitive advantages as distinct from the productive 
advantages we have considered so far. The first of these 



viii MONOPOLY AND COMBINATION 161 

is the boycott. If a trust has control of a large proportion 
of the supply of any commodity, the larger users of the 
commodity will probably be unable to meet their require- 
ments without buying from the trust at times. The trust 
can then refuse to supply them unless they undertake to 
buy exclusively from the trust ; by boycotting its com- 
petitors' customers it can force them to boycott its com- 
petitors. A slightly different method of seeming the same 
end, a monopoly of custom, is the method of the shipping 
conferences : a rebate, usually of 10 per cent, is allowed on 
all freights to shippers who confine their freights to the 
lines in the conference. The second weapon of the trust is 
price differentiation. Where the trust has a monopoly it 
can keep prices up ; with the revenue derived from these 
high prices at its disposal, it can afford to cut prices to 
bare prime cost of production in markets where it has not 
a monopoly, and so drive out its competitors. Under com- 
petitive conditions coal is cheapest at the pit-head and 
increases in cost as the distance from the pit increases 
owing to transport expenses ; the Westphalian Coal Cartel 
charges its highest prices in the coalfield itself, and reduces 
them in successive zones to meet the competition of coal 
from other coalfields. Differentiation is possible not only 
between districts but between individuals ; under com- 
petitive conditions a buyer who found that the firm he 
was buying from was supplying some one else at a lower 
price would take his custom elsewhere ; under monopoly 
he has no alternative. Trusts cut prices on a bigger scale, 
naturally, than independent firms when they do engage 
in price-wars ; with their enormous capital and predominant 
control of supply they can hold out for a rise longer, and 
resist a fall in price longer, than a single firm with competi- 
tion to think of. Their chief competitive advantage, how- 

M 



162 ECONOMICS chap, vm 

ever, is perhaps their knowledge of the supply ; in bargain- 
ing with customers, the trust knows, the customer does not 
know, what the available supply is ; hence the trust dare, 
and the customer dare not, stand out for its price. 



Vertical Combination 

We have been concerned in this chapter with the attempt 
to secure a monopoly of an industry or of one stage in an 
industry by the combination of all or most of the fii'ms 
engaged. It should be noticed that there is another form 
of combination, which has different objects, although it 
may tend ultimately to the establishment of monopoly. 
This is the combination of firms at different stages in the 
same industry, " vertical " combination as it has been 
called in contradistinction to the " horizontal " combina- 
tion, which we have been considering. It is due to the 
same pressure of competition on profits as leads to hori- 
zontal combination ; it seeks to escape from the pressm'e, 
however, not by combining competitors at the same stage, 
but by combining a firm with firms that supply it with its 
raw material or take from it its product. Such combina- 
tion can be most easily effected by the purchase by one 
company of shares in the companies from which it usually 
buys its materials and to which it sells its product. This 
kind of combination is often a step towards the other kind 
of combination, because competitors will often associate 
to acquire control of one of the sources of their raw material 
or for one of the outlets for their product, and, having once 
associated for that purpose, end by associating for all other 
purposes as well. 



CHAPTER IX 



MONEY 



Money and Coinage 

The modern producer is always a specialist ; every one in 
modern society derives his income from specialised labour 
or specialised property. This specialisation is, we have seen, 
possible only because the specialists co-operate : each by 
himself is incapable of satisfying his simplest material 
wants, together they can produce all that all need. The 
specialists, therefore, must excJiange their specialities. Ex- 
change may take place in two ways, directly and indirectly. 
The direct exchange of goods we call barter, the indirect 
exchange, through some medium, we call buying and 
selling. Barter is impracticable as a rule in a modern 
society, since it involves what has been called a " double 
coincidence of wants " ; under a system of barter, the 
barber who wants bread has to find not merely a baker 
but a baker who wants his hair-cutting, the baker who 
wants his haii- cut must find not merely a barber but a 
barber who wants bread. Even when two people who 
want each other's services have come together, they may 
be unable to agree as to terms ; the baker may consider 
two quartern loaves a fair equivalent to three hair-cuts, 

163 



164 ECONOMICS chap- 

while the barber demands a loaf each time he cuts the 
baker's hair. The degree of specialisation which char- 
acterises modern industry could never have been reached 
under a system of barter ; it is too minute^ too complicated, 
too extensive both in space and time ; the increasing use 
of money was both sign and cause of the transition from 
the primitive to the modern economy. 

The medium of exchange may be almost anything, pro- 
vided that it is generally acceptable. The sole object of 
having a single mediimi of exchange is to obviate the 
inconvenience of barter, and the inconvenience remains 
if some sellers refuse payment in the medium. The reason 
why a man with anything to sell wUl always accept pay- 
ment in money is that he knows that every one from whom 
he may wish to buy will accept money in payment ; if 
any number of people refuse to accept the medium in 
exchange for their goods, then its usefulness disappears. 
Cattle, slaves, tobacco, salt, leather, beads, silver, gold, 
paper, and several other things have in diiierent countries 
and at different times been used as the medium of exchange, 
and, consequently, as the standard of value. They served 
just so long as they were generally acceptable ; they gave 
way to something else, or to barter, when for any reason 
many people hesitated to accept them in payment for 
goods. 

Though paper money can circulate (under conditions 
explained later), it has been found in practice that the 
only way to secure in your medium of exchange this 
fundamental quality of general acceptability is to choose 
as your medium some commodity which has a utility for 
other purposes than facilitating exchange. Tin counters 
would pass from hand to hand as easily as golden sovereigns, 
and would make as good a medium of exchange, if people 



IX MONEY 165 

would accept them ; but in practice it has been proved 
over and over again that people will not part with their 
goods in exchange for counters with no inherent utility ; 
in the long run they have confidence only in money which 
derives its value not from the fiat of governments but from 
its intrinsic physical properties. The use of bank-notes, 
cheques, and bills of exchange may seem to contradict this 
principle, since the paper of which they are composed has 
no relation to their value. The contradiction is only 
superficial ; bank-notes and other credit instruments are 
legal documents giving the owner a legal claim to so much 
gold, and it is only because they represent this claim that 
they are acceptable ; if anything happens to create doubts 
that the claim will be met, they lose their acceptability 
immediately. So far from being valueless, because the 
paper on which they are written is valueless, they are forms 
of property in just the same sense as bearer Stock Exchange 
securities or the copyrighted manuscript of a book ; they 
are the title-deeds of property in bullion. 

Money is not only the medium of exchange ; it is also 
the standard of value. Since most exchanges take place 
through the medium of money, most goods and services 
come, at some time or other, to be compared with money. 
There is nothing else with which they are so regularly com- 
pared. Hence the medium of exchange becomes a common 
denominator of the relative values of different goods and 
services, and their values are usually stated in terms of 
money, i.e. as prices. 

The reason why the precious metals have superseded 
other commodities as money will now be evident. They 
have to a greater degree than any other commodity the 
qualities required in a medium of exchange and standard 
of value. They are compact ; silver displaced copper, and 



166 ECONOMICS chap. 

gold silver, as standard monej; because large payments in 
copper or silver were so cumbersome. They are durable ; 
it has been estimated that it would take eight thousand 
years for a sovereign to wear out completely— cattle are 
conspicuously lacking in this quality. They are divisible 
without loss of value ; in this quality cattle and most 
early forms of money are again conspicuously lacking, and 
precious stones, which have most of the other qualities 
required in money, fail in this respect. 

Gold and silver are easily recognisable, a quality necessary 
to check counterfeiting. Finally they are not subject to 
great changes in quantity. This last quality is most 
important in a standard of value ; one does not want one's 
standard of other things to be constantly changing itself. 
Corn, for example, wordd make a bad standard of value, 
because its quantity changes with every change in the 
weather and other conditions that affect the harvest ; a 
suit might exchange for a quarter of corn one year, and the 
next year, although the demand for suits and the conditions 
governing the supply of them remained unchanged, might 
exchange for a quarter and a half of corn, a record harvest 
having occurred in the interval. Gold and silver, on account 
of their great durabihty, are less subject to such changes 
than any other commodities ; each year's product is merely 
a small addition to an enormous stock already existing. 
Paper documents are even more compact, divisible, and 
recognisable than the precious metals, and will therefore 
make a more convenient currency, provided that they can 
be given that quality of general acceptability which the 
precious metals possess by virtue of their rarity and in- 
trinsic beauty. 

For convenience of handling and exchange gold and 
silver are usually coined. At first they were measured by 



IX MONEY 167 

weight ; a " pound " was a pound weight of silver. The 
process of coining was merely the authoritative stating 
and guaranteeing of weight and quality, to save the trouble 
of weighing and testing the metals each time a purchase 
was made. Metal stamped by authority in this way 
circulated more freely, because it was more convenient, 
than unstamped bullion. Governments made it the legal 
medium of exchange, and assumed the monopoly of the 
coining process. Usually the Government, in return for 
the convenience of coined money, would make a charge, 
putting less than a pound's weight of silver into a pound 
of money ; this profit or charge for coining is called 
seigniorage. To-day most governments take no seigniorage, 
i.e. make no profit on the coining of bullion. In some cases 
they take what is called brassage, i.e. they keep back out 
of the metal coined a quantity just sufiicient to cover the 
cost of the coining process. In the United Kingdom even 
this charge is not made ; gold is taken at the Mint and 
coined into sovereigns without charge, one ounce of gold 
(eleven-twelfths fine) into 3^4^ sovereigns. In practice, 
however, the holders of bullion take it not to the Mint but 
to the Bank of England, where they are credited with 
£3 : 17 : 9 for every ounce of gold (eleven-twelfths fine), 
instead of £3 : 17 : 10^, the exact equivalent ; the sacrifice 
of l|d. on the ounce of gold is made up for by the saving 
of the time taken by the process of coining. 

Any commodity will serve as the medium of exchange, 
provided that it is generally acceptable ; general accepta- 
bility, however, as a rule is enjoyed only by a commodity 
selected by Government as medium of exchange and 
" coined," or otherwise given the stamp of authority. 
The regulation of contracts is one of the most elementary 
functions of the State, and the contract of exchange, or sale 



168 ECONOMICS chap. 

and purchase, is one of the commonest and most important 
of contracts. To facilitate exchange the State selects one 
or more commodities as its standard money ; it makes it 
standard by giving it full legal tender. In the United King- 
dom gold is full legal tender, i.e. the ofier of it must be 
accepted in settlement of any debt. In addition, some 
subsidiary coins are usually issued as small change, wliich 
are not legal tender to any amount, but merely token coin- 
age, i.e. representative of the standard money. On such 
coinage the mint makes a large profit, since the face-value 
is always greater than the bullion-value. It follows that 
metals used for token coinage are not given the right of 
free coinage ; to grant free coinage would be to make the 
owner of the metal a present of the difference between the 
bullion-value and the face-value of the coin. It follows 
also, for reasons that will be apparent when we have studied 
Gresham's Law, that the Government can issue only a 
limited quantity of token coinage, and must limit the amount 
to which it must be accepted as legal tender. In the 
United Kingdom silver and copper coins are token coinage ; 
silver is legal tender only to the amount of forty shillings, 
copper of one shilling. 

II 

The Single Standard 

When we say that the medium of exchange is selected 
by the State, it must not be thought that the State can 
select anything, and, by selecting it, force people to accept 
it. If for any reason the currency issued by the State and 
given the quality of full legal tender is not liked, it ceases 
to facilitate exchange, and becomes one of the greatest 
obstacles known to exchange. General acceptability, 



IX MONEY 169 

though increased by the State's action, is given to a com- 
modity only by intrinsic utility ; and money to do its 
work must therefore possess intrinsic utility or give a claim 
to something with intrinsic utility, in addition to receiving 
the stamp of the Mint. To ensure this association of 
intrinsic utility with standard money, the metal selected 
as standard money is usually given the right of Free Coin- 
age ; this means that the Government will accept for 
coinage any amount of the metal. In the United Kingdom 
this right is possessed only by gold ; the Mint (or Bank of 
England for the Mint) will always accept gold and turn it 
into coin, while silver and copper are coined only on Govern- 
ment account. If a Government charges brassage or 
seigniorage on its coinage, this is no limitation of the right 
of free coinage. The object of giving the right of free 
coinage to a metal is to ensure that its value as bullion and 
its value as coin will always bear the same relation ; in 
the United Kingdom 31^-^ sovereigns and an ounce of gold 
are always of equal value, since the ounce of gold can at 
any time be turned into the 3^^^ sovereigns. The reason 
for this provision will be clear when we have considered 
Gresham's Law. 

Must there be only one standard of value, or may there 
be more than one ? Until the nineteenth century govern- 
ments saw no objection to maintaining two standards of 
value in circulation at the same time, namely, gold and 
silver. In 1816, however, the United Kingdom demonetised 
sUver, i.e. deprived silver of the legal attributes of full 
legal tender and free coinage, and all the other chief com- 
mercial countries have followed suit. Governments were 
forced to this action by the logic of facts ; the double 
standard was an illusion, in reality either gold or silver, 
not both, was the standard of value even when both enjoyed 



170 ECONOMICS chap. 

the privileges of standard money. Wlay this was so will 
be clear from an example. William III. issued a double 
coinage of guineas and shillings, both with full legal tender 
and free coinage. At that time gold and silver exchanged 
in the bullion market in the ratio of 1 to 15-93. The Mint 
adopted this ratio, and, making allowance for the difierence 
in weight between the gold guinea and the silver shilling, 
gave the guinea the value of 22 shillings. To put it in another 
way, one ounce of gold was coined into the same amount 
of money as 15-93 ounces of silver ; the value of both coins 
as money was the same as their value as bullion ; the 31int 
Ratio between them was the same as the Bullion Ratio. 
In the course of the next few years the production of gold 
increased more rapidly relatively than the production of 
silver ; the amount of silver therefore that had to be given 
in exchange for a given amount of gold decreased ; by 1717 
the Bullion Ratio of gold and silver had fallen from 
1 : 15-93 to 1 : 15-21. On the advice of Newton the Mint 
Eatio was altered accordingly, and the face-value of a 
guinea was reduced (without any reduction in the weight 
or fineness of the coin) to twenty-one shillings. Had this 
course been maintained, and the Mint Ratio between gold 
and silver coins been altered as often as the Bullion Ratio 
changed, gold and silver would have continued to circulate 
together. 

No fiu'ther change, however, in the Mint Ratio was made. 
The relatively greater increase in the production of gold 
continued, and consequently the ratio at which it exchanged 
for silver in the bullion markets fell correspondingly, until 
in 1760 one ounce of gold was exchanging for only 14-14 of 
silver, while the Mint was still coining an ounce of gold 
into as much money as 15-21 ounces of silver. The result 
of this v/as that silver coinage began to disappear from 



IX MONEY 171 

circulation ; the overvalued metal was driving tlie under- 
valued metal out of circulation. The reason was tins : 
people would not pay debts in silver coin when the silver 
was worth more as bullion than as coin ; it paid them to 
treat silver coin as bullion, so that only gold coin tended to 
circulate. A simple calculation will sliow the difficulty of 
maintaining in circulation together two metals at a Mint 
Ratio different from their Bullion Ratio. In 1760 the Mint, 
i.e. the Government, treated 100 guineas as equivalent to 
2100 shillings ; a person therefore who, starting with 100 
guineas, assiduously paid out guineas and hoarded all the 
shillings that came his way could substitute 2100 shillings 
for his 100 guineas. Then, ignoring the stamp on the coins 
and treating the shillings simply as so much metal, he could 
exchange the silver in the bullion market for gold, and 
(since the ratio in which gold and silver exchanged as 
bullion was 1 : M-14:, instead of 1 : 15-21, the ratio in which 
they were treated by the Mint) he could get for his silver 
a weight of gold sufficient to make 107-|- guineas ; this gold 
he could then take to the Mint, and get coined, under the 
free coinage regulations, into 107| guineas, thus making 
a profit of 7| guineas. After 1760 the production of silver 
began to increase. By 1800 it had increased to such an 
extent that the bullion ratio of gold and silver had become 
1 : 15-68. Silver was now the overvalued metal, and began 
to drive gold out of circulation. The Government, however, 
intervened, stopped the free coinage oi silver — provisionally 
in 1798 and absolutely in 1816 — thus placing the coinage 
of the United Kingdom on a mono-metallic gold basis. 

Thus, even when a Government tries to maintain the 
two metals in circulation together as standard money, 
it fails, because the relative value of the two metals is 
constantly fluctuating with the varying rates of their 



172 ECONOMICS ciLiP. 

production ; the metal undervalued by the Mint tends to 
disappear from circulation, so that the country is really on 
a mono-metallic basis, the metal overvalued by the Mint 
being the actual standard of value. Only if the chief 
commercial countries of the world combined to maintain 
both metals in circulation, could this result be prevented. 
The use of them as coin is much the most important use 
of the precious metals ; a " combine " of Mints therefore 
could control the bullion market and fix the values of bullion, 
just as any strong combine can to some extent control 
values. Then a fixed ratio between the two metals could 
be maintained in the bullion market, and no divergence 
between the Bullion Ratio and the universal Mint Ratio 
need occur. Such a treatment of the precious metal would 
constitute not a double standard but a joint standard ; its 
advantage over existing mono-metallic monetary systems 
would lie in the fact that the value of gold and silver 
together would probably fluctuate less than the value of 
either gold or silver separately. It would also get rid of the 
difficulty caused by the absence of a par of exchange 
between gold-using and silver-using countries. 

Ill 

Gresham's Law 

The disappearance of the undervalued metal when tv,^o 
metals are minted as standard money is only one illustra- 
tion of a general tendency, that has been called " Gresham's 
Law," after an Elizabethan finance minister who was 
supposed (incorrectly) to have discovered it. The tendency 
is for " bad " money to drive out of circulation " good " 
money. " Bad " money may be either coin, the value of 
which as metal is very much less than its face-value, or 



IX MONEY 173 

paper which cannot be exchanged for good coin. Coin 
may become bad money by being clipped or sweated ; 
or the Government may have debased it by increasing the 
proportion of alloy or reducing the weight without changing 
the denomination. The EngHsh pound declined from 4995 
grains of silver in the eleventh centmy to 288 grains in 
the reign of Edward VI. Or a change in the ratio of gold 
to silver in the bullion market may, as in the case of the 
English guinea, destroy the identity between the face- 
value and the bulKon- value of one of the two metals. 
Paper money becomes bad money whenever it is issued in 
excess of the requirements of the community for a medium 
of exchange ; it usually is issued in such excess when it is 
the only form of currency. Gresham's Law may operate 
in more than one ways The bad money will be used to 
pay debts, while the good money is hoarded ; every one 
tries to get rid of a bad shilling, so that bad shillings circu- 
late. The good money disappears chiefly, however, by being 
exported ; the Government cannot com^^elforeign merchants 
to accept its bad money in payment of their debts, they 
will usually accept only money which is worth no less as 
bullion than as coin ; hence the good money is constantly 
being saved up to pay foreign debts, and so leaves the 
country. 

This tendency operates only if two conditions obtain : 
first, that there is no scarcity of money. A certain amount 
of money is needed at any time for commerce ; if this 
amount is not forthcoming, then the need of money will 
prevent that hoarding and export of " good " money which 
usually cause its disappearance. Governments, by allowing 
no free coinage and by regulating the amount of money in 
circulation themselves, instead of leaving it to be determined 
by the production of gold and the action of banks, can make 



174 ECONOMICS chap. 

almost any kind of money circulate ; such regulation is, 
however, a delicate and difficult business owing to the 
constant change in the need for money, due to trade- 
fluctuation, and still more to the fact that trade is not 
confined within the boundaries of the State, while the 
authority of the Government is so confined. The second 
condition is that the " bad " money actually circulate. 
If the business community refuse to have anything to do 
with it, as the Americans of the Pacific States did with the 
greenbacks of the Federal Government during the American 
Civil War, the issue of the " bad " money will not affect 
the circulation of the " good." 

IV 

Paper Currency 

There are many substitutes for metallic money. The 
first is inconvertible paper currency, which has sometimes 
been called " fiat " money. It is made by the mere statement 
by a Government that such and such a piece of paper is such 
and such an amount of money. Sometimes the statement 
takes the form of a promise that payment in metal will be 
made ; since the promise is indefinite, and is not intended 
to be fulfilled, the difference of form is unimportant. Such 
money is put into circulation by the Government using it 
to pay its debts.; It circulates because the Government 
forces its debtors to accept it, and authorises them to settle 
their debts with it also. Such money, as Ricardo pointed 
out, is simply money with a seigniorage of 100 per cent. In 
the long run the Government does not make all profit, since 
the money comes back to it in payment of Government 
dues and taxes. The danger of the issue of such money is 
that it will be over-issued — i.e. issued in excess of the needs 



15 MONEY 175 

of the communit}'' for a medium of exchange. The tempta- 
tion to over-issue is strong, since the only expense of pro- 
ducing the money lies in the cost of paper and printing, 
and it is extremely difficult to estimate what amount is 
needed. Trade fluctuates, and with it the demand for money, 
so that even if the paper originally issued was no more than 
suflS.cient to meet current requirements, it will become 
excessive when trade falls off. If the Government that 
issued it is not very stable there is additional obstacle to 
its circulation, and its pm^chasing power may fluctuate with 
the fortunes of the Government, as the American green- 
backs did with the fortunes of the Federal Army in the 
American Civil War. It is an inelastic currency, since the 
supply of it, though easily extended, is not easily reduced 
when trade falls ofi ; in this respect it differs from bank 
credits, which are to be explained later. Once it de- 
preciates, it begins to drive all good money out of the country, 
in accordance with Gresham's Law. 

History affords plenty of examples of the evils of an in- 
convertible paper currency money. The notes of the French 
Eevolutionary Government called assignats, issued on what 
seemed excellent security, namely the land confiscated from 
the Church, depreciated in comparison with metallic money, 
because the holders of the notes could never get hold of the 
land the notes were supposed to represent, and at one time 
200 francs in assignats were needed to purchase the same 
amount of anything as one silver franc, English Bank of 
England notes between 1797 and 1819 were inconvertible, 
i.e. could not be exchanged for gold on demand, and de- 
preciated 15 per cent. The greenbacks issued by the 
United States Government to the extent of 450 million 
dollars depreciated at one time 65 pej cent, as compared 
with the gold dollar. Such money is no use for foreign 



176 ECONOMICS chap. 

payments. Its great evil, however, is the uncertainty it 
introduces into business. It neither possesses intrinsic 
utility nor represents anything possessing intrinsic utility ; 
its purchasing power, therefore, fluctuates with every change 
in trade, and no one knows ivJiat exactly he is being offered 
when he is offered payment in it. The over-issue of it by 
a Government is mere robbery, equivalent to the payment 
of a debt with a cheque that the payer knows will not be 
honoured. 

At the opposite extreme to inconvertible paper currency 
is the bullion certificate. To this class belong the United 
States gold and silver certificates,^ and, with the exception 
of about £20,000,000 issued against secmities, Bank of 
England notes. They are paper documents issued merely 
to save the trouble of handling large amoimts of metal ; 
their convertibility, i.e. the power to exchange them on 
demand for gold, is secured by a cent per cent reserve. 

A third type of paper money is the bank or Government 
" note." It is a promise or order to pay gold on demand ; 
it differs therefore from our first type of paper money in 
being convertible. Unlike the bullion certificate, however, 
its convertibility is not secured by the deposit in reserve of 
gold to the same amount as the issue of notes ; a reserve of 
gold is kept, but not a cent per cent reserve. The bank or 
Government that issues notes knows fi'om experience that 
not all the notes will ever be presented for cash payment 
at once ; it maintains a cash reserve against them, therefore, 
sufficient only to pay cash for so many as are likely to be 
presented. These notes — they will be dealt with again in 
the next chapter as forms of credit — are a currency created 
in Europe chiefly by banks, in America by Government as 
well as banks. They have the quality of general accepta- 
bility, because, although they have themselves no intrinsic 



IX MONEY 177 

value^ they are convertible, i.e. can be exclianged on demand 
for gold. They represent a great economy in the use of 
gold, since the gold reserve required as the basis for a note 
issue is only a fraction of the amount of the issue. This 
economy, however, introduces a risk which is not present 
in the case of bullion certificates ; this risk is the simul- 
taneous presentation for cash payment of an amount of 
notes greater than the cash reserve. If this happens, the 
bank must fail, even if it have other assets to more than the 
value of the demands upon it, since a presented note is a 
legal demand for cash, not for any kind of property. The 
same danger may be put in another way : the bank may 
not keep an adequate reserve, i.e. an amount of cash or 
bullion sufficient to meet the possible demand for cash. 
The bank has sufficient motive to keep its reserve adequate, 
in the obligation which it is under to pay cash on demand for 
its notes ; but the profit made by increasing the note issue 
without increasing the reserve is a motive tending to action 
in the opposite direction. 

In England any additional issue of bank-notes was stopped 
by the Bank Act of 1844, and the cheque has taken the 
place of the note as the chief form of currency. A cheque 
is an order on a bank by some one who has a credit with the 
bank to pay cash to the person mentioned in the order. Its 
acceptability is secured by the same means as that of the 
note, namely by its convertibility ; and its convertibility 
is secured similarly by the bank's cash reserve. The 
cheque has several advantages over the note. It enables 
a payment involving fractions of a pound to be made without 
the use of small change ; only amounts which are multiples 
of five pounds can be paid by note. A cheque when it is 
presented for payment must be endorsed by the payee, 
and the endorsement is a receipt of payment. If the cheque 



178 ECONOMICS chap. 

be crossed, the bank on which it is drawn will pay the cash^. 
which the cheque orders them to pay, into a banking 
account only ; thus the payer has a check on the movement 
of his payment, and can transmit it by post without fear 
of its being misappropriated. Finally, every cheque goes 
through the signatory's bank, and the bank keeps account 
of all cheques ; hence the signatory's payment account 
is automatically kept for him : by passing his receipts as 
well as his payments through his banking account, he can 
have all his accounts kept for him. The cheque, however, 
does not circulate quite so freely as the note ; its accept- 
ability is not so general. This is due to the fact that its 
value depends on the solvency of the signatory to it, while 
a note has the credit of a well-known bank behind it. Also 
the payer of a cheque cannot pass on a better title to it than 
he has himself ; if A steals a cheque and uses it to pay a 
debt he owes B, the amount of the cheque can be recovered 
from B on discovery of the theft, while if A steals a bank- 
note and pays it to B who receives it in good faith and 
spends it again, the owner of the note cannot recover from 
B. In spite of these slight drawbacks the use of the cheque 
is growing more rapidly than that of any other medium of 
exchange. 

The only other substitute for metallic money that is of 
importance is the draft or bill of exchange. A bill of 
exchange may be described as a cheque drawn not on a 
bank but on a merchant. Its typical form is : 

£1010 

London, 
To MeBsrs. White & Co. September 28, 1913. 

Three months after date paj' to Messrs. Smith & Co., or order, 
the Bum of one thousand and ten pounds for value received. 

(Signed) Smith & Co. 



IX MONEY 179 

In this example, Smith & Co, are said to " draw on " 
White & Co. Smith & Co. will draw up the form and send 
it to White & Co. If the latter admit their liability, they 
will " accept " it, i.e. write across it " accepted, White & 
Co." ; they thereby make themselves liable to pay cash to 
the amount of £1010 on December 28, 1913. Smith & Co. 
can then either wait till the full three months have 
elapsed and then collect payment, or they can take it to 
a bank or bill-broker, who will " discount " it, i.e. give 
them cash for it, less interest for three months ; or they 
can use it to pay a debt to some other creditor. In 
either of the last two cases they will have to endorse the 
bill, thus making themselves liable to pay it when due, 
if the firm on which it is drawn are unable to meet their 
liability. A bill of exchange may be used to settle a 
dozen debts and travel half round the world ; each firm 
that uses it to pay a debt will endorse it, making them- 
selves liable to meet it when it falls due, if none of the firms 
whose names appear earlier on it are able to do so. The 
phrase " for value received " should be noticed. Usually 
it is true ; the bill is a payment for goods which have been 
sent by the drawer to the drawee, and the bill is almost 
equivalent to an invoice. Sometimes, however, the phrase 
is a mere form ; the bill is then a device for making a loan, 
and is known as a Finance Bill or Accommodation Bill. 



CHAPTEE X 



BANKING AND CREDIT 



The Cancelling of Indebtedness by the Use of Credit- 
Instruments 

We have seen tliat the use of money is a device to facilitate 
exchange. We have seen that the one quality essential in 
money is acceptability, and that the easiest way to give 
money that essential quality is to use as money a commodity 
acceptable and valued on account of its intrinsic properties. 
The English sovereign is money of this kind, " cash " as it 
is called to distinguish it from other forms of money, and 
is acceptable everywhere, because its value depends not on 
the government stamp upon it, but on its material. The 
use of such money to the exclusion of all other kinds is, 
however, impracticable, the amount and frequency of 
commercial exchanges being too great for them all to take 
place through the medium of gold. Consequently certain 
paper substitutes for cash have come into use, which save 
society the labour which would be required to extract from 
the earth a store of gold large enough to serve as the medium 
for all exchanges. Cash is expensive to society ; all the 
kinds of paper money we have examined economise cash. 
We have now to proceed beyond a bare description of them, 
and enquire Iww they eSect this economy of cash. 

180 



CHAP. X BANKING AND CREDIT 181 

It should be noticed lirst of all liow the essential quality 
of acceptability is secured for paper money. In the case of 
inconvertible paper money issued by a government, or with 
the authority of a government, acceptability is secured by 
law ; by law the paper is legal tender, the oSer of it must 
be accepted as full settlement of debts. This method is 
unsatisfactory, since, as we have seen, this method cannot 
be relied on to secure for the paper acceptability at 'par, i.e. 
acceptability at its nominal value measured in gold. In 
the case of all other kinds of paper money the quality of 
acceptability is secured by making them " convertible," i.e. 
exchangeable for gold. Bank-notes, cheques and bills of ex- 
change are not gold, but they are all promises to pay gold ; 
they give their holder a claim to gold, and on the whole, 
therefore, enjoy the same acceptability as gold itself. 

Now if sellers who had received payment for their goods 
in these paper claims invariably demanded the gold which 
these papers entitled them to claim, there would be no 
economy of gold ; payments would be deferred, but would 
still be gold payments. The reason why these credit in- 
struments economise gold is that they are not as a rule 
presented for payment in this way ; they are transferred 
from one person to another until the claims which a man 
creates against himself by buying and the claims which he 
acquires over others by selling are brought together and can- 
celled, the difference only, and usually not even that, being 
paid in gold. 

This cancelling may be efiected in any of several ways. 
Suppose Adams, a farmer, sells all his butter to the village 
store-keeper Brown, and also buys from Brown all his 
groceries. Brown will not hand over to Adams sovereigns 
every time he receives a consignment of butter, he will 
instead make a note of the value received ; and Adams will 



182 ECONOMICS chap. 

not pay Brown casli every time he takes from the store a 
pound of tea, instead he will tell Brown to put it down in 
the account. Once a month or once a quarter, a balance will 
be struck ; Brown will find, perhaps, that he has received 
£25's worth of butter and sold £20's worth of groceries ; 
he will cancel the £20 of his claim on Adams against £20 
of Adams' claim on him, and need hand over in actual cash 
only the balance, £5. 

Suppose again that the farmer Adams instead of selling 
his butter to Brown from whom he got his groceries, sold it 
to a butter-factor, Clark, who was Brown's landlord ; then 
there might be a similar elimination of cash-dealings by the 
cancelling of debts. Adams owes Brown £20 for groceries, 
Brown owes Clark £20 for rent, and Clark owes Adams 
£25 for butter. Adams instead of giving Brown twenty 
sovereigns gives him a promissory note of some kind for 
the amount, intending to meet the note when Clark has 
paid him for his butter ; Brown induces Clark to accept 
the note in settlement of his rent, and Clark hands it over 
with five sovereigns to Adams in payment for the butter. 
Thus exchanges to the amount of £65 will have taken place 
and only five sovereigns have been transferred. 

Cases as simple as this are not likely to occur often ; 
but the case illustrates the possibility of economising gold 
by a system of cancelling the debts which a man incurs by 
buying against the claims he acquires by selling. The 
difiiculties in the way of a general use of this simple system 
of carrying on exchange are three : Adams' business may 
be perfectly solvent and yet his name be unknown. In that 
case, bills or drafts drawn on him will not have the quality 
of acceptability once they get outside the immediate circle 
of his acquaintances. Secondly, Adams' creditor may have 
perfect faith in Adams' ultimate solvency, and yet doubt 



X BANKING AND CEEDIT 183 

his ability to produce at a moment's notice the cash which 
the note is a promise to pay. If he is likely to want cash 
himself therefore^ he will refuse Adams' note (politely, 
one hopes) and insist on gold sovereigns. The third 
difficulty is this : modern commerce is extremely compli- 
cated, specialisation is carried so far that every business 
man has relations with great numbers of sellers or buyers ; 
it is extremely unlikely, therefore, that the note which 
Adams successfully launched in payment of his grocer's 
bill will find its way back to him in settlement of a claim 
he has on one of his customers. 

The banking system overcomes these difficulties. By 
an arrangement with the bank the business man who does 
not wish to pay gold, substitutes a draft on the bank (or 
cheque) for a draft on himself. This will have the accept- 
ability which his draft on himself lacked, firstly, because 
banks are comparatively few in number and their names 
well known over wide areas, secondly, because banks 
undertake to pay cash if cash is wanted. The bank over- 
comes also the third obstacle to the cancelling of indebted- 
ness, the obstacle offered by the wide extension and com- 
plexity of modern commerce. The arrangement which the 
business man has with the bank is an " account." This 
account gives him the right to draw on the bank for cash to 
the amount of the account ; in other words, it is a claim to 
cash which the bank will recognise and which he can transfer. 
Now Adams, Brown, and Clark in our imaginary instance 
would all have banking accounts. Adams, therefore, would 
pay his quarterly grocery bill to Brown not with a draft on 
himself but with a cheque. Now, a cheque is an order on 
the bank to pay gold, but the receiver of a cheque rarely 
exercises his right to demand gold, being content to pay 
the cheque into his own banking account. Brown, there- 



184: ECONOMICS chap. 

fore, would pay Adams' cheque into his account, and the 
bank would credit his account with an additional £20, at 
the same time deducting £20 from the amount standing 
in its books to Adams' credit. Similarly Brown would 
pay Clark with a cheque, and Clark would pay Adams with 
a cheque, the receiver in each case paying the cheque into 
his account. Thus Adams' banking account would be 
increased by the amount of his sale of butter, £25, and 
decreased by the amount of his purchase of groceries, 
£20 ; Brown's banking account would be increased by 
the amount of his sale of groceries and decreased by the 
amount of his rent ; Clark's account would be increased 
by the payment he receives from his tenant and decreased 
by the amount of his purchases of butter. Each has paid 
for his purchases, not with gold nor with a claim on him- 
self, but by transferring a portion of the claim on the bank 
which his account givea him ; each is paid for his sales in 
the same way. Thus at the hank the claims which each 
acquires over others by his sales and the claims which each 
gives others on himself by his purchases are brought 
together, cancelled so far as they balance each other, and 
the difference credited or debited to the account of each ; 
in our instance, at the close of the series of exchanges, 
Adams' banking account will be £5 higher than it was 
at the start, Clark's £5 less. Brown's as it was. 

It may happen, however, that there are two banks in 
the village, and that Adams has his banking account at 
a different bank from the other two ; we will call Adams' 
bank Barclay's and the other Lloyd's. Adams will then 
pay Brown with a cheque on Barclay's which Brown will 
pay into his account at Lloyd's ; this cheque will give 
Lloyd's Bank a claim for £20 on Barclay's Bank, since it 
is an order on Barclay's to pay Brown or his representative 



X BANKING AND CREDIT 185 

£20. Clark, on the other hand, will pay Adams with a 
cheque on Lloyd's, which Adams will place to his account 
at Barclay's ; this cheque gives Barclay's a claim to £20 from 
Lloyd's, and it is merely necessary for the representatives of 
the two banks to meet for these contrary claims to be set 
against each other and the balance, £5, paid by Lloyd's to 
Barclay's. The principle is exactly the same as in the 
previous case ; payment is made by the purchasers trans- 
ferring to the sellers claims on their banks, and the banks, 
being in touch with one another, can bring opposing claims 
together and cancel them. Even if the two banks are in 
different districts the same result will be brought about. 
All the banks in the country are connected through their 
head oj6&ces or London Agents in the London Clearing-House. 
Hence a cheque on any branch of Lloyd's, if paid into any 
branch of Barclay's, will be presented ultimately by the 
representative of Barclay's to the representative of Lloyd's 
in the Clearing-House ; then it will be balanced against 
cheques on Barclay's which have been paid into branches 
of Lloyd's, so that only the balance left over after cancelling 
contrary claims need be paid. Even this balance will not 
be paid in cash. All the chief banks have accounts with the 
Bank of England, the bankers' bank ; hence Lloyd's will 
pay Barclay's any balance which may be due, after allowing 
for contrary claims, with a cheque on the Bank of England, 
the Bank of England will deduct the amount of the cheque 
from Lloyd's account with them and add it to Barclay's, 
so that transactions to the amount of thousands of pounds 
may have been effected without the transfer of a single 
gold sovereign. The London Clearing-House meets twice 
a day, and effects payments to the amount of over nineteen 
thousand million pounds a year. 

Through the complex and far-reaching banking system 



186 ECONOMICS chap. 

the claims to cash. wMcli a man is constantly acquiring by 
selling his goods or his labour can be brought together and 
balanced against the claims which others are constantly 
acquiring on him by selling to him goods or services, so that 
he needs cash only for purposes of retail transactions. 
The banking system is a great clearing-house, in which 
sales and purchases are registered and thus cancelled against 
each other. Banking systems, however^ are national, not 
international ; there remains for consideration the case of 
international exchanges. These are efiected chiefly through 
the medium of the bill of exchange. The note which we 
imagined the farmer Adams giving to his creditor Brown 
was, in effect if not in form, a bill of exchange ; it was an 
undertaking to pay cash for value received at some future 
date. Brown used it to pay Clark, and Clark to pay Adams. 
Between the date when a bill is drawn and settles the first 
debt, and the date when it falls due and is presented for 
cash-payment, it may be used a score of times to settle a 
score of debts, perhaps in half a dozen diiferent countries. 
Bills of exchange are used in internal trade, but they 
arose in international trade and are the most usual method 
of making foreign payments. Suppose that an American 
merchant is buying English cloth to the value of £100 at 
the same time as a London merchant is buying American 
wheat to the value of £100. It would be a great waste of 
trouble if the American merchant shipped a hundred 
sovereigns across the Atlantic to pay the English manu- 
facturer, and at the same time the English corn-merchant 
shipped a hundred sovereigns to pay the American wheat- 
exporter. That trouble is saved by the American wheat- 
exporter drawing on the English corn-merchant for £100 ; 
the English corn-merchant accepts the bill and sends it 
back, the American corn-exporter then pays it into his bank, 



X BANKING AND CREDIT 187 

and through the banks and bill-brokers it comes into the 
hands of the American piece-merchant, who buys it and 
posts it to his English creditor, the manufacturer, who 
either holds it till it is due and then presents it to the corn- 
merchant for payment or pays it into his bank, and his 
bank collects payment when it is due. Thus through the 
medium of the bill, the English manufacturer's claim on 
the American piece-merchant is exchanged for a claim on 
a London corn-merchant, and the American corn-exporter's 
claim on the London corn-merchant is exchanged for a 
claim on an American piece-merchant ; both collect pay- 
ment at home, and no cash crosses the Atlantic. In practice 
the American corn-exporter will not draw on the English 
corn-merchant, but on some financial house that makes a 
business of creating bills. The English corn - merchant 
may be quite solvent and yet his name be unknown ; a bill 
drawn on him might be a good bill and yet be unacceptable 
simply because he was not well known, so that the American 
exporter when he got the bill would be unable to use it ; 
the primary essential of currency is acceptability, and his 
bill would lack that quality. The difficulty is got over by 
the English corn-merchant making an arrangement with a 
financial house ; they know him, and they themselves are 
known everywhere ; a bill on them will be acceptable, 
because they are known. The American exporter, therefore, 
draws on them, the English corn-merchant giving them 
security against loss and paying them for the use of their 
name. The principle of the transaction is the same as in 
payment by cheque. The purchaser who pays with a 
cheque transfers his claim on a bank to his creditor ; the 
purchaser who pays with a bill on a discount merchant, 
transfers the claim on this discount merchant which he has 
acquired by giving him security and paying for the use of 



188 ECONOMICS chap. 

Ms name. These financial houses that create bills of 
exchange are frequently firms originally engaged in general 
merchanting, who found that their reputation was so good 
that they could literally " trade upon it " by selling bills 
of exchange drawn upon them. 

The net result of the use of cheques and bills of exchange 
is to substitute an institution — the Money Market, which 
includes banks^ discount merchants^ and bill-brokers — -for 
a commodity — gold — as the medium of exchange. If I have 
textiles for sale and I want corn^ I do not exchange my 
textiles for gold and the gold for corn ; I exchange the 
textiles for a claim on a bank, and the claim on the bank 
for corn ; gold is eliminated as the medium of exchange 
(though it remains the standard of value), and the institu- 
tion comes in. The man to whom I give my textiles says 
the bank will pay me. He transfers his claim on the bank 
to me, and I tell the man from whom I get the corn that 
my bank will pay him. I transfer my claim on the bank to 
him. // everybody always used this method of negotiating 
exchanges, there need be no gold ; all purchases and all sales 
would be registered in some bank, so that a man's sales 
could always be set against his purchases. But somebody 
always and everybody sometimes wants the gold to which the 
cheque, note, or bill gives a claim. Hence banks have to 
keep a reserve of gold, and gold remains the basis of all 
exchange. 

/' " . 

The Ctkation of Credit by Banks 

We have seen that most payments in wholesale commerce 
to-day are made not in gold but in promises to pay gold 
or in credit instruments that constitute a claim to gold. 
The man who sells goods receives a cheque or bill which 

/ 



X BANKING AND CKEDIT 189 

gives him a claim to gold ; the man who buys goods pays 
with a cheque or bill which represents a claim to gold. We 
have seen that in the banking system all claims of this 
nature are brought together, all sales and purchases are, 
as it were, registered, so that the claims against a man (on 
account of his purchases) may be set against the claims he 
has on others (on account of his sales), and the balance only 
paid to him or collected from him. For a claim on himself 
the purchaser by arrangement substitutes a claim on his 
bank or some well-known financial house, i.e. he pays with 
a draft, not on himself but on the bank (a cheque) or on 
the financial house (a bill of exchange). He is paid with 
similar cheques and bills, most of which he pays into his 
banking account. Thus, in his banking account the claims 
which his sales give him against others are set against the 
claims which his purchases give others against him. 

This " arrangement," by which the purchaser is able to 
give a draft on a bank instead of allowing his creditor to 
draw on him, is called a " banking account." An account 
may be created, either by the client paying in something to 
the bank or by the bank making an advance to the client. 
In the first case the client places in the bank's keeping a 
portion of his wealth, which the bank is at liberty to use 
as it thinks fit, so long as it can return his wealth on demand 
or due notice ; in return for the use of his wealth the bank 
will either pay him interest or transact his banking business 
for him without making any charge for the service. In 
the second case, in return for the payment of interest, the 
bank treats a client, who has not given the bank his wealth 
to use, in exactly the same way as it treats a client who has. 
What the banker in effect says to his client is, " Give me 
security and pay me interest, and I will pay your debts for 
you in precisely the same way as I do those of a client who 



190 ECONOMICS chap. 

has placed in my keeping a portion of his wealth for that 
purpose." The client to whom a credit is allowed by a 
bank has to give some sort of security for repayment ; but 
this security differs from the deposit against which the 
holder of a deposit account can draw cheques, inasmuch as 
the bank cannot use it in any way except as security. If, 
for example, I deposit five hundred sovereigns with a bank, 
the bank can immediately lend them to somebody else ; 
if I receive a credit of £500 and give as security my life- 
insurance policy, the bank can do nothing with that, so 
long as I satisfy the conditions on which the credit 
was granted. But whether a bank's client has acquired 
the right to draw cheques on the bank by depositing 
wealth with the bank or by receiving an advance from 
it, he has that right ; the bank undertakes to honour 
cheques signed by him, i.e. to pay cash for them if asked 
to do so. An account which gives this right to draw 
cheques, however acquired, is a " Current Account." 
Banks will also receive money on deposit and pay interest 
on it, on condition that it is not withdrawn without the 
giving of some days' notice ; an arrangement of tliis kind 
is a " Deposit Account." 

Suppose a bank has made an advance of this kind ; the 
bank's client will wish to use the advance, and will use it 
by drawing cheques to the amoimt of the advance to pay 
his creditors. Now his creditors in nine cases out of ten 
will not cash these cheques, but will pay them into their 
banking account as deposits ; thus the advance made by 
one bank becomes a deposit in another bank, or, it may be, 
in the same bank. If the creditor to whom the bank's 
client pays the cheques which he draws against his advance 
has an account with the same bank, the bank has merely to 
make two entries in its books, deducting the amount of the 



X BANKING AND CEEDIT 191 

cheque from one account and placing it to the other ; if 
the cheques are paid into some other bank^ they will be set 
against cheques drawn on this other bank and paid into the 
first bank, when the representatives of the two banks meet 
in the Clearing-House. Thus while deposits or advances are 
distinct from the point of view of the individual client or 
bank, from the point of view of the banking system as a 
whole deposits and advances are largely identical. 

We can see now how banks are able to " manufacture 
credit/' we might almost say " manufacture money." At 
first they accepted deposits of gold and loaned them out 
again, acting merely as middlemen between those who had 
and those who wanted cash. Now they accept deposits 
which they loan out again, and in addition make advances 
which have no deposits against them, by creating claims on 
themselves which their clients can transfer in payment for 
their pm'chases. The bank makes an advance to a client of 
£1000 ; this means that it undertakes to meet the claims for 
gold on its client to the amount of £1000 ; it has increased 
its liabilities by £1000, and this will appear in its balance 
sheet in the form of an additional £1000 added to its 
Current and Deposit Accounts, while there is a corre- 
sponding increase in its assets appearing in the balance 
sheet in the form of £1000 added to its Advances to 
Customers on Security. When a bank makes an advance 
of £1000 a mutual liability is created between the bank and 
its client ; the bank incurs a liability to find 1000 sovereigns 
if called on, and the client incurs a liability to repay the 
bank £1000 when called on. The bank can incur this 
liability only because it is never called on to meet it 
in full ; the cHents to whom it makes advances draw 
cheques against those advances to pay their debts, but the 
cheques are never all presented for cash payment ; most of 



192 ECONOMICS chap. 

them always are paid into other banks as deposits and are 
cancelled against cheques on these other banks, which are 
paid into the first bank as deposits. A bank can safely 
make advances because those advances will most of them 
become deposits in other banks, just as its own deposits 
consist largely of claims on other banks which have made 
advances to their clients. 

Ill 

The Cash Reserve 

Are there any limits to this power that banks have of 
" manufacturing credit," and so increasing the amount of 
currency ? It is obviously profitable to them, since their 
clients pay them interest on these cheque credits in pre- 
cisely the same way as they would if the loan consisted 
of other clients' deposits, on which the bank was paying 
interest itself. There are limits. The extreme theoretical 
limit is the amount of security which the clients have to 
offer for advances ; since, however, banks will sometimes 
make an advance simply on the security of a client's good 
name, this extreme limit is vague and practically unim- 
portant. The real limit is imposed by the need of keeping 
a cash reserve against the liabilities involved in all accounts, 
credit as well as deposit accounts. Any one with an account 
at the bank can draw cheques, and a cheque is an order on 
the bank to fay gold (or Bank of England notes representing 
gold), which the bank undertakes to honour. Usually a 
cheque drawn on one bank is paid into another bank and 
simply cancelled with a cheque drawn on the second bank 
and deposited with the first. If people were always content 
to trust the bank, and to make and receive all payments by 
cheque, then banks need keep no cash reserve. But every- 



X BANKING AND CREDIT 193 

body at some time needs gold. The demand for gold^ or, to 
put the same thing in another way^ the extent to which 
people will be satisfied with payment by cheque or other 
credit instruments, varies, so that the cash reserve which a 
bank needs varies also ; but an adequate cash reserve the 
bank must keep. A cheque is an order to pay cash. A 
glance at a bank's balance-sheet will show that a small 
proportion only of its assets are cash, yet none of the other 
assets will serve instead of cash, if there is anything in the 
natm-e of a " run " on the bank ; cheques cannot be met by 
the offer of investments, the securities held against advances, 
bank buildings, or any of the other assets, and in such a time 
it will be impossible to call in loans or to realise any of the 
assets, except at a heavy loss. It is essential, therefore, that 
a bank keep a cash reserve adequate to meet all the demands 
for cash that wUl be made by clients who have deposits 
with or advances from the bank ; it is almost as essential 
that the bank keep its assets " liquid," i.e. invest its resources 
in such a way that they are not " locked up " and can be 
converted into cash at short notice. 

Here is the banker's dilemma. By keeping a large cash 
reserve in proportion to his liabilities, he will secure safety ; 
but he will reduce his profits, since the cash reserve earns 
him no interest, and he may embarrass his clients, who rely 
on him for advances and may be seriously inconvenienced, 
perhaps even driven into bankruptcy, if he contracts his 
credits in order to strengthen his reserve. If, on the other 
hand, he keep a small reserve, freely giving his clients the 
advances they ask for and increasing his profits by reducing 
the proportion of his assets lying idle, then he will be jeopard- 
ising security ; in case of a collapse of confidence in the 
business world, he will be unable to meet the demands for 
cash made upon him, and may involve in his ruin many 

o 



194 ECONOMICS chap. 

of his clients who had relied on him to supply them with 
cash. 

It is not the amount of the cash reserve that is the im- 
portant thing in banking, but the proportion of cash reserve 
to liabilities, i.e. to current and deposit accounts ; it would 
be a futile precaution to fix the amount either of reserve or 
of advances. And the proportion which the reserve must 
bear to the liabilities is not fixed ; it varies with the state 
of confidence in the money market and the needs of business. 
A credit system is a system based on trust ; when business 
men have no reason to distrust one another's ability to pay 
cash, they will not insist on cash and will be content with 
promises to pay cash, i.e. credit instruments ; when they 
have reason to be distrustful, they will want cash. When 
credit is good, " credits " may be increased ; when credit 
is bad, " credits " must be reduced — in other words, the 
proportion which the cash reserve bears to the liabilities to 
find cash must be increased. In the National Banks of the 
United States the law requires a 25 per cent reserve to be 
kept ; the provision fails of its object, because in normal 
times 25 per cent is a larger reserve than is needed, while 
in times of stress it is not large enough. English banks 
keep no fixed proportion of cash reserve to liabihties, and 
seldom keep a 25 per cent reserve ; but by strengthening 
their reserve in anticipation of any unusual call for gold they 
have been able for over a generation to meet all demands on 
them, even in such a crisis as that of 1907. 

The cash reserve of the English banking system as a 
whole is probably smaller, in proportion to liabilities to find 
cash, than is the case in any other country, and the reserve 
is concentrated at a single point in a way that is not found 
elsewhere. The other banks keep the gi'eater part of their 
reserves in the form of a deposit with the Bank of England, 



X BANKING AND CREDIT 195 

They do this (although the bank pays no interest on such 
deposits) partly because the Bank of England has facilities 
which the other banks lack for safeguarding large amounts 
of bullion, partly in order that they may be able to pay one 
another clearing-house balances in cheques on the Bank of 
England. Now the Bank itself, in addition to acting thus 
as the banker's bank, does an ordinary banking business, 
and therefore loans out its deposits to customers, discounts 
bills of exchange, and makes advances on other security, 
keeping only a proportion of its assets in cash or bullion. 
It keeps a much bigger cash reserve in proportion to its 
liabilities than any other bank ; still the other banks treat 
their deposits with the Bank as equivalent to cash, so that 
the reserve which the banks state that they are keeping 
against their liabilities is not altogether a cash reserve ; 
the Bank of England's own banking transactions reduce 
still further the amount of actual cash kept as a reserve 
against the liability of all banks to pay cash, if called on, to 
the amount of their current and deposit accounts. 

The law has permitted yet a further deduction ; the 
Bank Charter Act of 1844, while forbidding the issue of 
notes additional to the notes already in circulation except 
against an equivalent deposit of coin or bullion, permitted 
the Bank to issue £14,000,000 against securities. ^ The 
Bank is in two departments, a Banking Department and a 
Note Issue Department ; the Banking Department places 
all gold that comes to it in the Note Issue Department, 
taking out notes in exchange. Thus the " cash " reserve of 
the Banking Department is a reserve of notes, and of these 

1 This amount had been mcreaeed by 19G0 to £17,775,000 by the 
provision in the Act that when a bank with the right to issue notes 
lost that right by amalgamation with a London bank, or any other 
cause, the Bank of England might increase its note issue against 
securities by two-thirds of the amount of the lapsed issue. 



196 ECONOMICS chap. 

notes some twenty millions are issued against securities, not 
against gold. The credit system of England is like a 
pyramid^ the apex of which is the gold reserve ; but the 
pyramid rests not on its base, but on its apex, and the 
balance of it depends on the judgment of the managers and 
directors of the banks that compose it, above all on the 
judgment of the directors of the Bank of England. 

English bankers are not required by law to maintain any 
definite proportion between their cash reserve and their 
liabilities. This system is defended, as against the system 
of a legal minimum, on the grounds that it is both more 
economical and safer ; more economical because it permits a 
reduction in the cash reserve lying idle, when the temper of 
the money market is confident ; safer, because it throws on 
the banker the full responsibility of maintaining an adequate 
reserve, so that he will be constantly anticipating changes 
in the market with a view to strengthening his reserve 
before the need comes, instead of relying on a statutory 
20 per cent or 25 per cent reserve. This constant anticipa- 
tion of the demand for cash, and variation of the reserve in 
accordance with it, is the most important part of the banker's 
work, and controls English banking policy. In England a 
banker is expected to keep his assets liquid, in order to 
protect his reserve. A distinguished banker once said that 
the art of banking lay in being able to distinguish between 
a Bill of Exchange and a Mortgage, because a Bill of 
Exchange is the chief example of a liquid asset, while a 
Mortgage locks up one's money for a long term of years. 
A bank's assets, as stated in a balance-sheet, illustrate this 
principle. First comes " Cash in hand and at Bank of 
England," essential to the banker's work because needed to 
meet demands for cash, but a comparatively small propor- 
tion of the whole because earning the bank no interest. 



X BANKING AND CREDIT 197 

Next " Loans at call and short notice " ; these are advances 
to bill-brokers and stockbrokers^ at a very low rate of 
interest in consideration of the fact that the bank can insist 
on repayment without notice or at very short notice. Next, 
the most important item, " Bills discounted and advances 
to customers." The advances are made on some security 
and, being made for a definite term, take the bank's assets 
out of its control only for that term. The " Bills Dis- 
counted " are really only a special kind of " advance to 
customers." A client of the bank, having sold goods to 
a customer in another country, has been paid with a bill 
due, say, in three months ; he wants the money at once, 
and goes to the bank, who take the bill from him at its face 
value less three months' interest or discount. The trans- 
action is really a loan on the security of the biU, since the 
client will have to endorse the bill, thus making himself 
liable to meet it when it becomes due, if the person on whom 
it is drawn does not do so ; at the same time it is just the 
kind of investment the bank wants, since it is secure — the 
goods should have reached the foreign customer, been 
sold and provided him with the money to meet the bill by 
the time the three months have elapsed — and it ties the 
bank for three months only. Next come " Investments," 
earning for the bank a good rate of interest, but a compara- 
tively small proportion of the whole assets because they 
are of little use in times of stringency for strengthening 
the reserve. Last come " Bank premises, etc.," a small 
item. 

The method by which a bank protects its reserve will be 
clear from this consideration of its assets. The banker 
will watch all the signs of the market, and, if he anticipates 
a demand for cash, will restrict his advances and discount 
fewer bills. Meanwhile advances made previously will 



198 ECONOMICS chap. 

come to the end of their term and bills held by the bank will 
fall due, so that the banker will be acquiring " claims to 
cash " to set against the claims which the bank's current 
and deposit account holders have on the bank, and thus 
the proportion which the cash reserve bears to the out- 
standing liabilities is increased. The restriction of credit 
must not be done suddenly ; so many businesses are 
dependent on advances from banks that a sudden with- 
drawal of these advances by the banks wordd precipitate 
many into bankruptcy and perhaps produce a financial 
crisis. The device by which a gradual and safe restriction 
is effected is the raising of the rate of interest charged for 
advances and the rate of discount charged on bills. By 
this device those who can possibly do without the bank's 
assistance will do so to avoid the expense of the higher rate 
of interest, while those who must have the assistance will 
be able to get it by paying for it. The Bank of England 
will always discount a bill with two London names on it ; 
the rate of discount which it charges is the " Bank Rate," 
settled by the Board every Thursday. In normal times 
bills are not brought to the Bank, because the joint-stock 
banks and bill-brokers will discount them cheaper ; but 
in times of stringency, when the other banks and the bill- 
brokers can spare no cash, the holders of bills who must 
have cash are forced to go to the Bank, and the Bank Rate 
becomes effective, i.e. it becomes the lowest rate at which 
bills can be discounted. When the Bank Rate rises above 
6 or 7 per cent, however, it will probably pay the 
holders of gold in other money centres to send their gold 
to London to earn this high rate of interest, and, directly 
or indirectly, the gold will come, and so relieve the pressiu:e 
on the English cash reserve. 

The Bank, it was said above, will always give gold for 



s BANKING AND CKEDIT 199 

a bill with, two London names on it — even if it has to go 
into the bullion market to buy gold and discounts the bill 
at a loss to itself. This practice is important^ because 
no other financial centre can be relied upon to pay gold 
in a time of stringency. In Berlin^ in times of stringency, 
the issue of notes (which, are legal tender in Germany) can 
be increased ; in Paris the bank has the right to meet 
demands on its notes in silver ; in New York the banks 
have in the past proved unable to pay gold. Hence 
bills in London are in times of stringency the only bills 
which enjoy general acceptability, since they alone can 
be with certainty converted into gold, and in such times 
people insist on gold. Bills on Berlin, Paris, and New 
York are at such times of use only to purchase bills on 
London. Because it is the only centre that undertakes, 
and can be relied on, to convert its credit instruments into 
gold at all times, London is the chief money market of the 
world ; it is the chief clearing-house of the world's com- 
mercial exchanges. 

IV 

The Social Utility of the Credit System 

There remains for consideration the broad question of 
the social utility of this banking and credit system which 
we have been studying. How does it aid production ? 
Is it essential to the modern organisation of industry or 
(as some think) a useless and dangerous excrescence, 
maintained merely because so many people are interested 
in its profits ? Briefly it may be said that the system is 
essential and fundamental. The principle underlying the 
whole of modern industry is the productiveness of specialisa- 
tion. Specialisation, we have seen, involves exchange and 
production in anticipation of demand. The credit system 



200 ECONOMICS chap 

facilitates exchange and finances 'production in anticipation 
of demand. 

It facilitates exchange. Direct exchange or barter is 
clumsy. The use of a commodity, in the form of coin, as 
a medium of exchange is clumsy ; imagine the amount of 
gold and silver that would be needed if all modern commerce 
were carried on on a basis of specie payments ! The credit 
system enables us to substitute an order on a bank or a bill 
of exchange, a promise to pay cash, for cash itself, and then 
bring these promises together and cancel them. It is a 
sort of clearing-house, in which a man's debts and claims 
are brought together and set against each other. A reserve 
of gold is still needed, but only a reserve. For the com- 
modity, gold, we have substituted as our medium of 
exchange the institution, the bank. This is the earliest 
function of the credit system ; the bill of exchange arose 
centuries before the bank-note, to obviate the necessity 
of shipping bullion to pay for imports ; and early banks, 
like the Bank of Amsterdam described by Adam Smith, 
were established to supply, not credit, but a satisfactory 
medium of exchange. 

The credit system finances production in anticipation 
of demand. We have seen how specialisation necessitates 
production in anticipation of demand ; it makes the process 
of production so lengthy and roundabout that it has to be 
commenced months and perhaps years before the product 
will be wanted. Payment, however, is not made by the 
consumer until he receives the finished product. When 
I pay 10s. for a flannel shirt, I receive a finished commodity 
which the retailer stocked perhaps a month ago, the whole- 
saler perhaps three months ago ; the flannel of which it is 
made was manufactured nine months ago, out of yarn spun 
twelve months ago, and the wool was grown two years ago ; 



X BANKING AND CREDIT 201 

bmldings and machinery were required to carry through 
the different processes of manufacture, coal to drive the 
machinery, and means of transport to convey the material 
from one stage of production to the next. Scores of firms 
have incurred expenditure months and years before I pay 
my ten shillings, in order that the shirt may be ready. All 
relied on the ultimate sale of the shirt to reimburse them for 
their expenditure, but the expenditure had to be incurred 
first. The question is, how was this expenditure met ? 
The woollen shirt is only one transaction among millions, 
on all of which expenditure had to be incurred before pay- 
ment could be obtained. 

The first source from which such expenditure is met 
is current income from shirts abeady sold. The ten 
shillings I paid for a shirt two years ago may have just 
percolated to the farmer whose wool is in my new shirt ; 
the payment a farmer receives for last year's clip should 
normally meet the expenses of tliis year's. But many 
firms cannot afiord to wait for payment, and all firms at 
starting and at other times have to face periods during 
which there are no incomings to balance outgoings, since 
their products are either incomplete or cannot find a market 
at the moment. 

The second source is savings. Each person in the series 
has something in hand when he starts in business, with 
which to buy plant and materials, and to meet expenses 
until the products of the business begin to bring in an 
income. This is the chief resource ; without it specialisa- 
tion to the extent that it is found in modern industry could 
not be adopted. But it does not afford a complete answer 
to our problem, because its usefulness is limited by its 
amount and the number of times it can be turned over. 
For example, a retailer having bought stock would be bound 



202 ECONOMICS chap. 

to sell out that stock before he could get any new stock — 
even though he might find that something quite different 
was in demand. A manufacturer, having bought yarn and 
woven flannel from it, would have to sell and get paid for 
the flannel, before he could buy any more yarn to continue 
manufacturing. In these cases the difficulty might be 
overcome by the producer spreading his working capital 
over a large number of operations, so that some payments 
would always be coming in ; but the farmer could not do 
this. The farmer gets the greater part of his income at 
one period of the year, when he sells the clip ; if for any 
reason, such as drought, he be forced to incur unusual ex- 
penses, and cash dealings were the only method of payment, 
he would go bankrupt, although he might have wool and 
mutton growing sufficient to meet all his expenses. Simi- 
larly a hop-farmer might have all his working capital tied 
up in a promising crop ; the crop is attacked by a blight, 
but can be saved if he can go to the expense of washing it ; 
if the two resources we have dealt with so far were the only 
resources available, he could not save it. And all businesses, 
commercial and industrial as well as farming, would be un- 
able — without credit in some form or other — to extend their 
operations to meet a growing demand, except by the slow 
process of saving. The flannel manufacturer, for example, 
might be absolutely certain that he could sell double the 
quantity he sold last year and yet be unable to make more 
than last year — unless he can raise money now on the value 
of his next year's output, and with it buy additional yarn, 
plant, labom", etc. 

This is what the credit system enables him to do. The 
credit system affords, in addition to income and savings, a 
third and most elastic resource from which the expenditure 
incurred in producing ahead of demand can be met. Credit 



X BANKING AND CREDIT 203 

is the exchange of " present " goods for " future " goods. 
On the assurance that you will be able to pay when your 
product is completed and sold_, you can borrow now the 
wherewithal to purchase goods now. The bill of exchange 
and bank credit are the means by which you are enabled 
to do this. The farmer, needing machinery to harvest 
his crop, pays for the machinery with the bill, drawn on 
and accepted by himself, or accepted by some London 
house for him ; when the wheat is harvested with the aid 
of the machinery, this bill will be used to pay for his wheat ; 
i.e. through the bill the corn which will be harvested with 
the aid of the machinery has paid for (or been exchanged 
for) the machinery. The bill tides over the interval between 
the use of the machinery and production of the crop. The 
crop, when harvested, will be worth more than enough to 
pay for the machinery and meet all other expenses ; but 
the machinery is needed to harvest the crop. The farmer, 
therefore, buys the machinery with a promise secured on the 
crop, i.e. exchanges the "' future " crop for the " present " 
machinery. The machinery maker accepts payment in a 
bill, due, say, three months hence, because he can discount 
it with a bank, if he wants cash now ; and the bank dis- 
counting his bill is really meeting for the farmer, until his 
crop is harvested, the claim against him which his purchase 
of machinery has created. 

Or suppose the wheat is grown and harvested ; an 
English importer buys it and gives his acceptance of a bill 
payable in three months. He cannot pay cash for the 
wheat until he has sold it himself, and he cannot sell it 
until it has reached England, all of which takes time ; but 
he cannot get it to England, where it is wanted, without 
giving the farmer something — because the farmer wants 
to get on with his farming, or may have to meet a biU 



204 ECONOMICS chap. 

which he gave in payment for machinery ; so he gives the 
farmer a promise to pay in three months (by which time he 
will have got the corn to England and sold it) ; the farmer 
discounts the bill, i.e. a bank takes it from him and under- 
takes to meet all claims on him for cash to the amount of 
the bill (less discount) ; the bank can wait until the three 
months have elapsed, because it has a cash reserve sufficient 
to meet any claims for actual cash, and can rely on being 
able to cancel any cheques drawn on it by the farmer 
against cheques drawn on other banks and deposited 
with it. 

The bill of exchange, which the bank will take, giving to 
the holder in exchange an account subject to his cheques, 
is the chief means by which international commerce is 
carried on ; the term of the bill tides the importer over the 
interval between his purchase of the goods in the foreign 
country and the sale of them in his own. The same 
function is performed by the bank if, instead of discounting 
the bill received by the farmer in our last instance, it makes 
the corn -importer an advance. The importer uses the 
advance to pay for the corn, and repays it when he has 
sold the corn ; the bank undertakes, this time as before, 
to meet all claims against the value of that corn between 
the time when it is grown in America and the time when it 
is sold in England. This grant of an advance by banks is 
the most usual method of financing production in anticipa- 
tion of demand. Suppose our flannel manufacturer foresees 
a big demand for tennis flannels ; he is already working 
up to the limit of his capital, but he is so sure that additional 
flannel can be sold that he wishes to increase his output. 
The only way he can do this is to go to the bank, convince 
them that his anticipations are correct and also give them 
security for repayment, and so get a loan from them with 



X BANKING AND CREDIT 205 

which to increase his production. He has borrowed on 
the assurance that with the loan he will be able to produce 
more, and the increased product will more than repay the 
loan ; the additional materials^ labour^ etc., which he 
purchases with the loan are really paid for bj'', i.e. exchanged 
for, the additional flannel they produce. The banks, with 
their cash reserves and their system of cancelling claims for 
cash against each other, can give loans or advances^ to 
increase production in the form of promises to pay cash 
or claims to cash without having to produce more than a 
small proportion of actual cash. In every case the bank 
enables the producer to realise now a portion of the future 
value of his product, and so enables him to produce that 
product. 

The bank enables him to do this by taking on itself the 
responsibility for finding any cash that may be claimed from 
him between the time when he commences his part of the 
productive process and the time when he completes it ; 
the bank can undertake this responsibility, while others 
cannot, because the bank is the institution through which 
purchases and receipts are brought together and cancelled 
against each other, the bank's cash reserve being maintained 
to meet such demands as there are for actual cash. The 
real security on which a bank relies, when it makes the 
advance to a business man, is the additional product which 
the advance will enable him to put on the market ; it 
requires him, as a rule, to give it other security, in case 
his undertaking prove a failure, but the nature of this 
other security is exactly indicated by its name, " collateral 
security," and it is always a great nuisance to a bank to 
have to realise the collateral security in order to secure 
repayment of an advance. Collateral security is like the 
pledge left with a pawnbroker for repayment of a loan ; 



206 ECONOMICS chap, x 

if we did not expect to be able to repay the loan, we should 
sell the pledge, not pawn it. 

Thus the credit system is needed to finance the produc- 
tion in anticipation of demand to which specialisation leads ; 
and its special function is to give elasticity to the productive 
organisation in response to the constant fluctuation in 
demand. It also has the effect of neutralising to a great 
extent the irregularity of nature ; it enables the farmer to 
derive from his farm a regular income, month by month, 
instead of receiving his whole year's income in one gulp 
when the harvest comes in and is sold ; it does so by enabling 
him to begin to draw on the value of his next harvest as 
soon as the growing of it has begun ; financiers will accept 
bills for him because they rely on his harvest to enable him 
to meet the bills when due. Because the credit system 
facilitates exchange and assists production in anticipation 
of demand, it makes possible the extreme specialisation 
which is the chief source of the material wealth of modern 
societies. It is therefore fundamental to modern industry, 
in the same way and to the same degree as are the means of 
transport ; it developed as they developed, and, though its 
working is not so obvious as are bridges, embankments, and 
docks, it is as important. 



CHAPTER XI 



THE LEVEL OF PRICES AND FOREIGN EXCHANGES 



The Measurement of Changes in the Level of Prices 

A PRICE is the amount of money for wliicli a commodity 
ezchanges in the market. Since most commodities are 
exchanged for money, money becomes the standard of 
value ; instead of saying that a bicycle is worth three 
quarters of wheat, we say that the bicycle is worth £6 : 15s. 
and wheat is worth 45s. a quarter. If the price of a com- 
modity rises, we take it as an indication that its value has 
risen, i.e. that we can get in exchange for it more of other 
commodities than we could before ; if its price falls, we 
expect to get less of other commodities in exchange for it. 
Sometimes, however, we find that the price of a thing has 
gone up, and yet the thing will exchange for no more of 
other commodities than it would before, because the 
prices of most other commodities have gone up at the same 
time ; the price of a bicycle, for example, may have gone 
up to £9, and the bicycle still exchange for three quarters of 
wheat only, because the price of wheat has gone up to £3 
a quarter. When a change in f rices occurs with apparently 
no corresponding change in values, we are forced to the 
conclusion that the change is not in the things exchanged 
for money, but in the money for which the things are 

207 



208' ECONOMICS chap. 

exchanged. In other words^ changes in the general level 
of prices mean that money, like other things, has its value, 
and that its value is subject to change like other values. 
We say a certain suit is worth £3 : 17 : 10| ; it would be 
just as true to say that one ounce of gold (the bullion 
equivalent of £3 : 17 : 10| in coin) is worth that suit of 
clothes. If ten years later we find a similar suit worth 
£5 : 16 : 10, and that most other things that formerly were 
worth £3 : 17 : 10| are now worth about £5 : 16 : 10, we 
shall be forced to the conclusion not that the value of suits 
has changed (except in relation to money), but that the 
value of money has changed ; it has fallen, since half as 
much money again has to be given to get a suit, and most 
other things, as was needed ten years ago. More usually, 
instead of saying that the value of money has changed, we 
say that its purchasing power has changed ; the meaning 
is the same, since the purchasing power of money is its 
power to exchange for other things. 

Changes in the value of most things are measured by 
reference to money and expressed in prices ; obviously 
changes in the value of money cannot be measured by 
reference to money. They can, however, be measured 
with as much accuracy, at any rate, as changes in the value 
of other things are measured by money. No other single 
commodity will serve as a standard of money's fluctuations, 
since no single commodity is free from fluctuations in value 
greater than the fluctuations of money ; if any commodity 
were capable of indicating fluctuations in the value of 
money, it would have displaced gold as the basis of currency. 
If, however, we can get the average fluctuations in price of a 
considerable number of commodities, this will give us the 
changes in the value or purchasing power of money ; this 
is done by making what is called an Index Number, A 



XI PRICES AND FOREIGN EXCHANGES 209 

number of commodities are taken^ and the average price of 
a given quantity of eacli in a given year noted ; tlie prices 
are tlien totalled up and form the standard with which 
variations will be compared. The variation in prices in any 
other year can then be measured by totalling the average 
prices for this other year of the same quantities of the same 
commodities, and expressing this total as a percentage of 
the total for the standard year. The Board of Trade pub- 
lishes an index number based on forty-five principal com- 
modities with the year 1900 as standard ; in 1913 the index 
number stood at 116-5, showing that average prices had 
risen in the meantime 16-5 per cent, which is the same thing 
as saying that the value or purchasing power of money 
had fallen in the same proportion. It is a " weighted " 
average, i.e. different amounts of the forty-five commodities 
are taken, in accordance with the estimated consumption, 
in making up the representative total ; but weighted 
averages do not give results that differ significantly from 
unweighted averages. The prices on which most index 
numbers are based are wholesale, not retail prices, although 
retail prices are the prices that concern the general public 
immediately. It is more difficult, however, to get retail 
prices than to get wholesale prices, and the quality of 
finished commodities in shops varies more than the quality 
of raw materials ; the statistician, therefore, is forced to 
take the prices of raw materials and food-stufis, and it 
is not unreasonable to assume that the relation of retail 
to wholesale prices will not be materially different at the 
different periods under comparison. 

The effects of the changes in the purchasing power of 
money, wliich the device of index numbers enables us to 
measure, are important. Contracts are frequent which 
cover a period of years ; a change in the general level of 

? 



210 ECONOMICS chap. 

prices during the period alters the conditions of tlie contract. 
A farmer, for example, may take a farm on a seven years' 
lease at a rate based on current wheat prices ; a general 
fall in prices takes place, and the farmer finds himself still 
bound to pay a rent based on high prices, while the prices 
he is receiving for his produce are low. A general rise in 
prices is adverse to the interests of all people with fixed 
incomes, since their money incomes will purchase for them 
less commodities. It is usually adverse to the interest of 
wage-earners. They are, as a class, less skilled at bar- 
gaining, and have less knowledge of market conditions, than 
the employers to whom they sell their labour ; they do not 
therefore secure an increase in wages proportionate to the 
increased cost of living. On the other hand, a period of 
falling prices usually means an increase in the real wages of 
the wage-earners ; this is so because, as a class, they resist 
reductions of their money-wages when prices are falling 
more stubbornly and with more success than they demand 
increases in times of rising prices. Business men as a class 
and capitalists benefit by rising prices. Production is a 
lengthy process ; there is a possibility at each stage in it 
of buying materials and labour at one level of prices and 
selling the products at a new and higher level. They get 
what the classes with fi:xed incomes and the wage-earners 
lose ; the " labour unrest " of the last few years of rising 
prices has been accompanied by a rapid and, in the aggregate, 
enormous increase in the amount of income assessed for 
Income Tax. 

II 

Causes of Changes in the Level of Prices 

What are the causes of these changes in the value or 
purchasing power of money ? If gold were the only kind 



XI PRICES AND FOREIGN EXCHANGES 211 

of money in use^ the cause would be clear ;, viz. a change in 
the quantity of gold relative to other things. Gold is a 
commodity like other things, and its value will be affected 
by a change in its supply, just as the values of other things 
are afEected by changes in their supply. If the supply of 
gold increases faster than the supply of other things, then 
more gold will have to be given in exchange for those other 
things ; if at one time a suit could be obtained in exchange 
for one ounce of gold, or £3 : 17 : 10|, after a great increase 
in the production of gold, accompanied by no corresponding 
increase in the faciHties for producing suits, a man will 
have to give more than one ounce of gold for a suit, perhaps 
an ounce and a half, or £5 : 16 : 10. To-day, however, gold 
forms only a small proportion of the money in use ; can 
we still find a connection between the quantity of gold and 
the value of money ? The answer would seem to be that 
the influence of the production of gold on the level of prices 
is greater than ever it was, but is indirect. 

Formerly, when the precious metals were the only 
important medium of exchange, the influence on the level 
of prices of an increase in the quantity of the precious 
metals was direct. The owners of the new gold or silver 
offered it in exchange for the commodities they wished to 
purchase, and, in order to secure them, offered more of it 
than others were doing ; thus they set a new and higher gold 
or silver price for the commodities they pm^chased. It may 
be objected that if the new wealth they had acquii-ed had 
been not gold or silver, but something else, the effect would 
have been the same ; they would have been enabled by their 
new wealth to outbid competitors for the commodities they 
wanted, and so force the prices of these commodities up. 
That is true, but if their new wealth had been anything but 
gold or silver, had been, for example, some merchandise, 



212 ECONOMICS chap. 

then the rise in price of the commodities they purchased 
would have been counterbalanced by the fall in price^ due 
to the increase in the supply of it, of the kind of merchandise 
that they brought into the market. It is only when the 
new wealth which enables its holders to force up the prices 
of the commodities they want is money of some sort that 
the rise in price they cause is counterbalanced by no fall in 
price elsewhere ; it is counterbalanced by no fall in price, 
because it is itself a fall in the value of money. 

To-day the direct influence still operates, since the holders 
of the new gold will use it for purchases ; it is, however, 
comparatively unimportant, first, because the proportion of 
gold payments to other payments is small, and secondly, 
because new gold nearly always as a matter of fact finds its 
way to some bank ; the owners of the new gold prefer the 
convenient right to draw cheques on a bank to the in- 
convenient necessity of handling and safeguarding large 
quantities of bullion. Now banks, as we saw, create currency 
or money by giving to their clients credits subject to cheques 
in return for security. The extent to which they will make 
such advances with a given cash reserve varies with the 
state of feeling in business ; but, other things being equal, 
as their cash reserve increases they can and will increase 
their advances, that is to say, the amount of currency or 
money that they create. Thus an addition to the supply of 
gold will indirectly, by increasing the cash reserves of the 
banking system, increase the amount of money in circulatioii 
by much more than the amount of gold brought in. The 
new money, whether it be an advance which a bank has 
granted on the basis of its increased cash reserve, or a current 
account which one of the owners of the new gold has acquired 
by depositing his gold with a bank, will enable its holders 
to offer more for the commodities which they want than 



XI PRICES AND FOREIGN EXCHANGES 213 

they would otlierwise have been willing and able to give ; 
the prices of these commodities will rise^ and the rise in 
price beginning with them will be transmitted to other 
commodities^ since the sellers of them will be enabled by 
the higher prices they receive to offer higher prices for 
other commodities which they want. Thus an increase 
in gold-production can still affect prices, although the 
proportion of payments actually made in gold is small ; 
it affects prices chiefly through bank reserves, increasing 
them, and thereby enabling the banks to increase their 
advances. Until a generation ago, the growth of the world's 
gold supply was slow and barely kept pace, if it did keep 
pace, with the increase of wealth in other forms, for each 
year's addition was insignificant compared with the existing 
accumulations of the past. During the last generation the 
discovery of new goldfields, together with the discovery of 
the cyanide process of extracting gold from the ore, has 
altered this ; since 1889 the annual increase in the world's 
supply of gold has been so great that we may expect the 
world's total supply to be doubled in the course of two 
generations. It is unnecessary therefore to look further 
for the chief explanation of the recent rise in prices. 

There are, however, other influences. An increase in 
gold-production will raise prices only when it is greater 
than the increase in other forms of wealth ; it is the relation 
between the two that influences the level of prices. Hence 
a great increase in ^old-production may be counterbalanced 
by a more rapid increase in other forms of wealth, due to the 
progress of technical invention or the opening up of new 
countries with great and untouched natural resources, so 
that prices will even tend to fall. Or an increase in gold- 
production, in itself not very great, may be accompanied by 
a falling off in the production of other important forms of 



214 ECONOMICS chap. 

wealthy and prices will rise faster than they have done when 
the rate of gold-production has been greater. Such a falling 
off may be a contributory influence in the recent rise in 
prices ; the world, and especially the United States, is 
filling up, the first fertility of virgin soils has been exhausted, 
and the secular struggle between invention and the tendency 
of nature to give decreasing returns to our expenditure on 
her may for the moment have gone against invention. 

There is another difficulty to be faced before we can 
understand the relation between the supply of money and 
the level of prices. Money is wanted, not for the sake of 
its intrinsic physical properties as are most commodities, 
but for the sake of its purchasing power, as a means of 
obtaining other things. If we use the word " money " 
strictly, and not as it is commonly used as a mere synonym 
for " wealth," we see that the want it satisfies is the want 
for a medium of exchange which every society practising 
specialisation experiences. The relation therefore on which 
the level of prices depends is not exactly the relation between 
the amount of money and the amount of other kinds of 
wealth, but the relation between the amount of money and 
the " amount of exchange " (if the phrase may be permitted) 
which that money has to effect ; and the amount of exchange 
depends partly, it is true, on the amount of other forms of 
wealth, increasing as a rule as that increases and decreasing 
as it decreases, but partly also on the frequency with which 
these other forms of wealth are exchanged. If the amount 
of money is stationary, then an increased amoimt of ex- 
change can be effected only at lower prices ; while an 
increase in the amount of money, occurring when there is 
no increase in the amount of exchange, will send prices up, 
since there will be more money to change hands every time 
a thing is bought or sold. The frequency of exchange 



XI PRICES AND FOREIGN EXCHANGES 215 

depends chiefly on the extent to which specialisation has 
been carried, and, since specialisation is constantly being 
carried further, the frequency of exchange tends to grow 
and to exert a depressing influence on prices. Where, 
however, specialisation takes place within the firm, it does 
not increase the frequency of exchange, and when a number 
of firms that formerly bought from and sold to one another 
are combined into a single firm, the frequency of exchange 
will be reduced without any reduction in the extent of 
specialisation. 

Just as an increase in the frequency of exchanges in- 
creases the need for money and will force prices down if 
an increased supply of money is not forthcoming^ so any- 
thing that increases the rapidity with which money circulates 
and does its work will have the same effect as an increase 
in the actual amount of money, and tend to send prices up. 
Thus improvements in the means of communication may^ 
as one of their effects, tend to send prices up. An increase 
in the skill of bankers or in the stability of business, by 
enabling bankers to give more credit on the basis of a given 
cash reserve, will result in an actual increase in the amount 
of currency, tending to raise prices. 

The level of prices is the value of money. A rise in 
prices does not cause — it is a fall in the value of money, 
since it means that a given quantity of money will exchange 
for a smaller quantity than before of other things. A fall 
in prices is a rise in the value of money, since it means that 
a given quantity of money will exchange for a larger quantity 
than before of other things. The value of money depends, 
like the value of everything else, on the relation between 
the supply of it and the demand for it. The supply of 
money is made up almost entirely of gold and bills, cheques, 
and notes, which are all of them undertakings to pay gold ; 



216 ECONOMICS chap. 

any increase in the supply of gold^ by enabling an increase 
in the issue of these undertakings to pay gold, will eSect a 
more than proportionate increase in the supply of money. 
The demand for money is the amount of exchange that has 
to be effected by it ; this depends chiefly on the amount of 
other forms of wealth, but partly also on the frequency 
with which they exchange. Temporary changes in the 
demand for money can be met by banks increasing or 
diminishing their credits ; ultimately, however, these credits 
depend on and are limited by the gold reserve of the banks. 
In the long run, therefore, the chief influence on the level of 
prices, which is the same thing as the value of money, is 
the relation between the rate at which the supply of gold 
increases and the rate at which the supply of other kinds of 
wealth increases. 

Ill 

The Law of Comparative Cost 

It remains to consider international exchange, a subject 
we could not take up until we had seen how changes in the 
amount of gold affect the level of prices. Exchange takes 
place between countries for the same reason that it takes 
place between districts in the same country, because 
countries are specialised and can obtain some things they 
need more easily by offering their own special products in 
exchange for them than by producing them in their own 
area. Exchange between countries is as a rule more difficult 
than between different districts in the same country. The 
differences in language, in currency, in law and trading 
custom, the greater distances and the greater risk involved 
as a rule in foreign trade, are all obstacles to the free move- 
ment of goods ; to these must be added the obstacles 
deliberately imposed by governments in the shape of 



XI PRICES AND FOREIGN EXCHANGES 217 

import duties. In spite of them all^ however, the action 
of the middleman, buying in the cheapest and selhng in 
the dearest market, links countries together ever more 
closely, and international specialisation, with its correlative 
international exchange, increases. 

Climate, the character of the soil and mineral deposits, 
the density of population, the degree of industrial develop- 
ment, fit different countries for different branches of 
production ; hy the different countries giving most of 
their productive powers to the work for which they are 
most fitted, all benefit. Each utilises to a greater degree 
than would otherwise be possible its natural and social 
advantages, and obtains in exchange for its own products 
the products of other countries cheaper than it could produce 
them itself in the same quantity. Countries, however, 
often import from other countries commodities which the 
importing country could produce actually cheaper than the 
exporting country. Thus England imports dairy produce 
from Ireland and Denmark, although English pastures are 
no less fertile than the pastures of those countries, and 
wheat from India where methods of agriculture are im- 
measurably less advanced. Farming usually declines in a 
district when coal is discovered under the land and coal- 
working begun, although the fertility of the soil is not afEected 
by the new mining operations. The Channel Islands 
import wheat, using their land to raise more valuable 
vegetable and dairy products, and wine districts import 
commoner fruits which they could raise themselves at much 
less cost than the districts from which they import them. 
The fact that a commodity can be produced at a lower 
cost by one country than by another is no guarantee that 
it will pay the first country to produce it and not import 
it from the second ; there may be other commodities in the 



218 ECONOMICS chap. 

production of which the first country has an even greater 
advantage, in which case it will specialise in them. 

Thus it is the comparative cost of producing different com- 
modities in dilf erent countries that determines which country 
shall specialise in which commodity. A country may be able 
to produce each of a number of commodities cheaper than 
they can be produced in a second country with which it 
trades ; it will not therefore produce them all for itself 
(otherwise trade would cease between the two countries) ; it 
will concentrate on those commodities in the production of 
which it has the greatest advantage over the other country, 
while the other country will specialise in those commodities 
in the production of which it is at the least disadvantage. 

Both countries benefit by this arrangement. Each 
country, by specialising in those commodities for the produc- 
tion of which it has the greatest relative advantages, obtains 
a bigger return for its expenditure of labour and capital than 
it would have done if it had not specialised but had devoted 
part of its efforts to producing the commodities for which 
it was relatively less well fitted. The total product of the 
two countries together will be greater than if each had 
produced all the commodities without specialising. Each 
country will be able to offer the other in exchange for the 
other's special products a greater quantity of its own special 
products than the other could have produced for itself 
with the labour and capital it expended in producing tJie 
products it exported in exchange. If England can produce 
both fine cottons and coarse cottons better than Germany, 
but has a greater advantage over Germany in producing 
fine cottons than in producing coarse cottons, then the 
tendency will be for England to specialise in the finer 
cottons and Germany to specialise in the coarser cottons, 
and for the two to exchange their special products ; England 



SI PEICES AND FOREIGN EXCHANGES 219 

will be able to offer Germany more fine cottons in exciiauge 
for a given quantity of coarse cottons than Germany could 
have produced for herself with the same expenditure of 
labour and capital as was required to produce the coarse 
cottons which she exported, and England will obtain a 
greater quantity of coarse cottons than she could have 
produced with the labour and capital which she expended 
in the fine cottons which she exported. The cost of our 
imports is our exports ; so long as we can produce our 
exports with a less expenditure of labour and capital than 
would be required to produce at home the imports we get 
in exchange for our exports, we gain something, even if 
we could produce the things we import at a lower cost than 
the countries that send them to us. England could raise 
more of her food, but finds it cheaper to buy it with her 
manufactures from countries like Denmark and India that 
have not the coal required for manufactures ; England 
could make the coarse cottons she imports, but to do so 
would be to waste the relatively greater advantage which 
her more developed organisation and the higher skill of 
her artisans gives her in making the finer and more valuable 
cottons.; If her coal-fields became exhausted, or the dis- 
covery of some new and more efficient source of power 
deprived her of the relative advantages in manufacture 
which they now give her, then she might find that her 
facilities for agxiculture were, relatively to other countries, 
greater than her facilities for manufactm-es, and she might 
become again primarily an agricultural country, as she 
was before the eighteenth century. 



220 ECONOMICS chap. 

IV 

Imports paid for by Exports 

The cost of our imports is our exports. Our exports 
pay for our imports. This is not obvious, because the 
totals of the recorded imports and exports of any country 
rarely balance. The recorded imports and exports, how- 
ever, never account for all the exchange of goods and 
services between one country and the rest of the world. 
Records are kept only of material commodities, while a 
country usually supplies and receives from other countries 
services as well as commodities. To understand how a 
country's exports pay for its imports, therefore, it is neces- 
sary to take into account everything of market value that 
the country supplies to the rest of the world, and everything 
that it receives from the rest of the world. The United 
Kingdom, for example, supplies other countries not only 
with its exports, but with a large part of the services of its 
mercantile marine, and of its banking system and insurance 
companies ; since it receives much less than it gives in the 
case of shipping, banking, and insurance, it will have to 
receive more goods (or recorded imports) than it exports, to 
make up the difference. Further, citizens of the United 
Kingdom have a large amount of capital invested abroad ; 
some foreign capital is invested in England, but not nearly 
so much. Interest is due on this capital every year, so that 
the United Kingdom has another claim on other countries 
which will be liquidated in goods or recorded imports. The 
export of capital swells the total of recorded exports, the 
corresponding " import " being the scrip which constitutes 
the English investor's title to the foreign stock ; foreign 
investments in the United Kingdom swell the recorded 



XI PRICES AND FOREIGN EXCHANGES 221 

imports of the United Kingdom^ since the foreign capital 
will come in the form of goods^ British stocks and shares 
being exported in return ; similarly, repayment of British 
loans abroad will swell the British recorded imports. 

A comparison of the recorded imports and exports of a 
country therefore will tell us little ; to understand its economic 
relations with other countries we must take into account 
all the transactions that give it a claim on other countries 
and all the transactions that give other countries a claim 
on it : not only imports and exports of goods, which are 
recorded by Customs officers, but " invisible " imports and 
exports — stocks and shares, services of shipping, financial 
and insurance houses, hotel-keepers, etc., and claims to 
interest on foreign investments. So far as these two sets 
of claims balance they will cancel out, so far as they do 
not the balance will be settled by the transfer of gold ; 
but, for reasons which we have now to examine, they always 
tend to balance, and the movement of gold, when they do 
not balance, automatically sets at work forces that tend to 
restore the balance. 

Imports and exports — in the wide sense of these terms 
that we have just described — will always tend to balance, 
for the same reason that the purchases which an individual 
can make are usually equal in amount to the sales which he 
can efEect. The individual's purchases are limited by his 
income, which depends on the value of the services or 
commodities he sells to other people ; similarly, the 
purchases that a country can make are limited by the 
value of the goods and services that it can sell to other 
countries, unless it is to become bankrupt. But over a 
short period imports may exceed exports, or vice versa, 
and the balance will have to be settled by a transfer of 
gold. 



222 ECONOMICS 



The Balaiice of Trade and the Level of Prices 

From the point of view of the individual trader foreign 
trade is buying and selling, like home trade : in principle 
it does not difier at all. Since^ however, payments have to 
be made in another country, and perhaps in a different 
currency, they are usually made not by cheque but, as 
we have seen, by bill of exchange. An importer can pay 
for his import by accepting a bill drawn on him by his 
foreign creditor ; more usually he will arrange with a bank 
or financial house to accept for him bills drawn on them by 
his creditor. Or he can buy for cash in his own country 
a bill drawn on some one in the country of his creditor and 
payable there ; this he will send to his creditor in payment 
for his import. Or he can send bullion, which is much more 
expensive than sending a bill. Since a bill drawn on London 
is the only kind of bill which the holder can be sure of con- 
verting into gold in case of any failure of credit, bills drawn 
on London are preferred to bills drawn on any other com- 
mercial centre ; foreigners who send goods to England 
prefer drawing on London and selling the bill to some one 
wishful to pay for goods obtained from England, to being 
paid with bills, drawn on fellow-countrymen and payable 
in their own country, which have been accepted by fellow- 
countrymen who have bought goods from England. But 
however the bill is created, once it is created it becomes 
itself a sort of merchandise, dealt in by middlemen, and 
fluctuating in value. This is so because the drawers ot 
bills usually do not want to hold the bills till they fall due ; 
they want cash, and therefore discount them, and the banks 
or brokers into whose hands tliey thus come offer them for 



XI PRICES AND FOREIGN EXCHANGES 223 

sale to importers who have debts to pay in the country 
where they are payable. 

Now let us suppose that England has been buying from 
France more than France has been buying from England. 
Then there will be Englishmen with debts to pay in France 
of greater amount than the debts which Frenchmen have 
to pay in England. The claims that Englishmen have on 
Frenchmen will not balance the claims that Frenchmen 
have on Englishmen, and gold Avill have to be exported 
to France to pay the difference. Now it is expensive to 
send gold and insure it during transit ; hence bills which 
obviate the necessity will be at a premium. Bills will be 
at a premium in London, because more are wanted than 
are available, while bills will be at a discount in Paris, 
because there are more available than are needed to pay 
French debts in England. It may, however, happen that 
while England has bought more from France than she has 
sold to France, she may have sold more to Germany than 
she has bought from Germany, and Germany have sold 
more to France than Germany has bought from France. In 
that case the English traders will be able to purchase bills 
in Berlin which will be acceptable in France, where they 
will be used to meet German claims in France. Thus the 
indebtedness of England to France and Germany together 
and the claims of England on France and Germany together 
will just balance, and the transfer of gold be averted. But 
the existence of " three-cornered " exchanges like this does 
not alter the principle ; at any given time a country may 
have more debts to pay than it has claims to present to 
other countries, the exchanges will be " against " it, gold 
will have to be transmitted, and bills which have only a 
short term to run and obviate the necessity to transmit 
gold will rise above their face value. 



224 ECONOMICS chap. 

There are limits to the fluctuation in the value of bills. 
If the demand for a foreign bill so exceeds the supply that 
the premium on it rises above a certain pointy it is cheaper 
to pay the expense of sending bullion ; this sets an upper 
limit to the bill's fluctuation. If the supply so exceeds the 
demand that the value of the bill falls below a certain pointy 
it pays either to hold it until it falls due or to send it to 
the place on which it is drawn^ get it discounted, and pay 
the expenses of bringing the gold back. For example^ the 
bullion equivalent of an English sovereign in French money 
is 25-22 francs (called " the mint par ") ; it costs -07 fr. 
to transfer (and insure during transit) a sovereign between 
London and Paris ; hence the limits to the fluctuation in 
value of London bills in Paris or Paris bills in London are 
25-15 francs (25-22 --07 fi-ancs) and 25-29 (25-22 + -07) 
francs; these are called the "gold-points/' because they are 
the points at which it pays to transmit gold instead of 
bills. In the case of exchange with countries having a silver 
or inconvertible paper currency, we have corresponding 
" specie-points/' at which it pays to transmit specie ; 
but we cannot in this case state what these points will be, 
since there is no mint par of exchange, and the value of bills 
varies with the value of silver (or the inconvertible paper 
money) measured in gold, as well as with the changes in 
the supply of them and demand for them. It should be 
stated that there are certain exceptional cases, of no great 
importance, where the value of bills fluctuates beyond the 
limits set by the gold-points. 

Suppose England has been buying more than she has 
been selling, so that the exchange is against her and it 
becomes cheaper to transmit gold than it is to send bills, 
what is the effect of paying these foreign claims by sending 
gold out of the country ? We have seen that the level of 



XI PRICES AND FOREIGN EXCHANGES 225 

prices generally is intimately connected witb. the supply of 
gold ; over a short period the same intimate connection 
exists between the supply of gold in any one country and 
the level of prices^ since there are^ as we have seen^ obstacles 
to that free movement of wealth from country to\country 
which would be needed to maintain prices at a u|iiform 
level in all countries. Therefore when the foreign exchanges 
move against England and it becomes necessary to send gold 
out of the country, the level of prices in England will be 
affected. Banks, having their reserves depleted, will restrict 
their advances, thus lessening the purchasing power of the 
business community, and prices will fall. While prices are 
falling in England, the gold England is exporting will be 
having just the opposite effect in the countries to which 
it has been sent, that is to say, it will be raising the level of 
prices there. Now, the fall -in prices in England will make 
it profitable to foreigners to buy in England goods which 
previously they could get cheaper elsewhere, and will 
thus stimulate exports ; especially will foreigners take ad- 
vantage of the low prices to buy English Stock Exchange 
securities. At the same time the rise in prices in the 
countries to which the gold goes will check English purchases 
there. Hence the tendency of England to buy more than 
she sold, which gave rise to the unfavourable movement 
of the exchanges and the export of gold, will be reversed ; 
England will tend to buy less and sell more, and the balance 
between the claims for and against her will be restored. 
As a result of this change in the balance of trade, bills 
will become more plentiful at home and will fall within 
the upper gold-point ; they will become less plentiful 
abroad and will rise above the lower gold-point, so that 
the necessity for transmitting bullion disappears. 

Thus, international payments are settled by cancelling 



226 ECONOMICS chap, xi 

contrary claims through the medium of the bill of exchange. 
Gold is used only to settle balances when the claims which 
a country has on other countries do not quite equal the 
claims which other countries have on it ; and the movement 
of the gold starts a change in levels of prices which leads to 
a restoration of the balance between a country's purchases 
and its sales. 



CHAPTER XII 

THE CIRCULATION OF WEALTH 
I 

Wealth and Production 

We have not yet asked ourselves the question, " What is 
Wealth ? " It did not arise in our study of the economic 
structure of society ; but it must be faced before we go on 
to the study of distribution. In the deepest sense in which 
the word Wealth can be used Economics does not attempt 
to answer the question ; because in the deepest sense of the 
word the question " What is Wealth ? " is a moral question. 
Our view of true wealth depends on our moral and rehgious 
views. Christian and Mohammedan, artist and manu- 
facturer, scholar and drunkard, have different views as to 
what is true wealth. But in the ordinary use of the word 
they all agree ; in ordinary speech we ignore this deeper 
meaning of the word " Wealth," and Economics follows 
ordinary speech in this respect. 

In ordinary speech a wealthy man is a man with a large 
income. How do we state a man's income ? Usually in 
pounds, shillings, and pence, and in the same way we state 
a country's income in terms of money. So we say that the 
United Kingdom is a wealthy country, having an income 
of some two thousand millions a year. But the pounds, 

227 



228 ECONOMIOS chap. 

shillings, and. pence are not the wealth. No one^ except the 
miser^ desires them for their own sake ; they are wanted 
only for their purchasing power — we state wealth in terms 
of money merely because money is the only standard of 
wealth we have. The real wealth consists of the things 
that the money will purchase, and of those things we think 
when we try to realise what wealth is ; the precious metals 
and. precious stones, the materials and implements of manu- 
facture, food-stuffs, land, and buildings, these and not their 
money prices are what we mean by wealth. But there 
are other, less tangible things we buy with money — the 
surgeon's skill, the musician's art, the services of preacher 
and teacher, and a thousand others ; what have these in 
common with the tangible, obvious forms of wealth we 
thought of before ? They have only one quality in common, 
they satisfy human want and desire, and it is that quality 
that makes us regard them all as " wealth." 

The power to satisfy human want, or aid the satisfaction 
of human want — that is what the economist, following the 
usage of ordinary speech, requires of a thing to make it 
wealth. '' Anything that satisfies, directly or indii-ectly, a 
human want, and is not unlimited in quantity," is the defini- 
tion of wealth that Economics, following ordinary usage, 
has formulated. No matter what the want is, whether it is 
bad or good, men regard as wealth the means for satisfying 
it ; opium and quinine, Shakespeare's plays and the latest 
sensational novel, gold and iron, are all alike forms of 
wealth because they satisfy wants ; the production of them 
swells the national income and enriches their owner. The 
means of satisfying the want must not be unlimited in 
quantity, or it will not be regarded as wealth ; a thing 
must not only satisfy want, but must require some effort 
or sacrifice to acquire it, before it comes to be regarded as 



xn THE CIKCULATION OF WEALTH 229 

wealth in the ordinary sense of that word. Air and sun- 
light therefore, although far more important to life than 
steam-engines and gas supplies, do not count as wealth in 
the estimation of any individual's or any community's 
wealth, while the latter do. 

If wealth then is the satisfaction of human want, any one 
or anything that satisfies a human want or helps to satisfy 
it, is producing wealth. There are individuals in society 
who receive incomes without producing anything ; they 
are sometimes called parasites. Property - owners, for 
instance, receive income without producing anything ; but 
their property helps to satisfy human wants in the many 
ways we have seen. If it is land, it is the soiirce of raw 
materials ; if it is capital, it is producing in the form of 
machines, or keeping workers while they are engaged in 
the round-about methods of modern production. And in 
all Western countries the rule is, that anything that is 
produced by a thing is the property of that thing's owner. 
The rule may be a bad one — we shall criticise it in Chapter 
XXII. — but it differentiates property -owners from the 
parasite proper, who lives upon gifts, taking no part directly 
or indirectly in the productive process. It is sometimes 
thought again that such people as managers in factories 
and middlemen in commerce are not producers, because 
they do not alter in any way by their labour the shape of the 
materials of manufacture. As we have seen, however, these 
classes are necessary to organise the work of specialised 
workers, if society wishes to utilise the advantages of 
specialisation, and in that way they help production ; 
production would not be so large or so varied but for 
their work. 

The professions must also be regarded as productive. 
It is true that they produce nothing material or tangible. 



230 ECONOMICS chap. 

but they satisfy human wants. If the farmer is a producer 
because he produces food, the doctor must be considered 
one if he helps us to digest the food. If the workman is 
a producer because his skill shapes material objects to our 
needs, the technical teacher who has helped the workman 
to get that skill must be considered a producer ; and the 
technical teacher's work is based on the discoveries of pure 
science, which must therefore be regarded as productive. 
And the same is the case with the servants of governments. 
The ordinary work of production could not go on unless 
law and order were maintained. Men and women cannot 
live together in societies without rules to prevent them from 
getting in one another's way, and a whole machinery of 
government is needed to enact these rules and to see that 
they are carried out. Indirectly, therefore, civil servants 
and the judicial services are helping to satisfy human wants, 
i.e. are producing wealth. If, then, men's wants and desires 
were for material things only they could not be satisfied 
without the labours of all sorts of professional men, whose 
work therefore is productive. But " man doth not live 
by bread alone " ; human nature seeks satisfactions which 
are not given by material objects. It has other wants 
besides material ones, and any person v/ho satisfies these 
wants is producing wealth in exactly the same sense as the 
workers who produce any material object. The preacher 
and the teacher, the artist and the journalist are all of them 
engaged in satisfying human wants, are all of them producers. 
The view that only the production of material objects is 
true production would tell against the views of its holder 
if pushed to its logical conclusion. In that sense no man 
ever produces anything. The fundamental laws of physics 
are the conservation of energy and the indestructibility 
of matter, and what man does is to change the form of 



xn THE CIRCULATION OF WEALTH 231 

matter given by Nature, to change the kind and direction 
of energy given by Nature ; lie alters^ shapes, and directs 
forces, not creating anything. At the end of all his work 
there is the same weight of matter and the same volume of 
force in the universe as there was at the beginning. What 
all labour is directed to is the satisfaction of human wants, 
and that satisfaction is wealth, whether it is given directly 
in the form of services or indirectly by giving to some 
material object the shape and form which will enable it to 
satisfy human wants. 

II 

Income and Capital 

We have spoken throughout of " income " ; this is not 
in accord with the usual notion of wealth. The usual 
notion is that wealth consists of a stock or fund of objects, 
and that the wealth of a community could be stated in the 
form of an inventory of all the goods in the community. 
This view is partly due to the behef that only material 
objects form wealth, though, as we have seen, material 
objects themselves are only wealth because they have the 
capacity to satisfy human wants. Such an inventory 
would include much of the wealth of a community at any 
moment — its lands, its machines, its raw material and 
finished goods, its buildings and their furnishings, and so on ; 
but it would exclude some important forms of wealth, 
some important possessions which enable us to satisfy 
wants. It would exclude the skill of the workman and 
the knowledge of the scientist and the organisation of 
industry, all, that is to say, that enables us to keep up our 
stock of material objects, to replace what decays or wears 
out ; and it would ignore all that the professions can do 
to satisfy human wants, since it would include only the 



232 ECONOMICS chap. 

surgeon's instruments, while ignoring the skill that enables 
him to'use them. 

Such a method would be a very imperfect method of 
dealing even with material objects. What, for instance, 
would be the use of including in an inventory a machine 
without giving us any indication of what the machine could 
do ? It might give the original cost of the machine, but that 
is no indication of the capacity of the machine to satisfy 
wants, since the machine may be worn out or have become 
obsolete. It is only by the product of the machine, by 
the income which it will give, that we can tell its value, 
and if we wish to state the value of the machine in a lump 
sum we can do so only by capitahsing the income derivable 
from it, i.e. by calculating what sum of money would be 
needed at the current rate of interest to give an income 
of the value of the machine's product. If we wish to 
represent wealth as a fund or stock, we could get it only by 
capitalising incomes generally. The present value of a 
house is not what it cost to build, but so many years' 
purchase of the rent it will yield. The value of a doctor's 
skill is his income, multiplied by the number of years that 
he will be able to exercise his skill. If we wish, then, to 
measure the wealth of a society we can do it only by calculat- 
ing its income, not by totalling up the value of the goods 
it may possess at any moment. 

The notion that wealth is a stock or fund, and income 
the fruit of this stock, is a conclusion very easily drawn 
from certain aspects of production. Land gives an income 
in the form of crops, and the land remains when the crop 
has been taken. A flock gives an income in the form of 
the year's clip and the year's lambs, and the flock is there 
at the end of the year. A machine produces so much every 
year, and at the end of the year the machine remains appar- 



xn THE CmCULATION OF WEALTH 233 

ently much as it was at the beginning. We invest our 
savings in some company, and each year we draw a dividend 
on our capital which leaves the capital unimpaired and 
ready to yield a dividend next year. This view does not 
go below the surface. The dividend is not always paid. 
It is not paid when the expenses of the business exceed the 
receipts. When it is paid, it does not represent the whole 
of the product of the business for the year, because, before 
the business could pay any dividend at all, it has had to 
pay out of its product all the expenses for labour, manage- 
ment, and materials. It has had to replace from the same 
product all the wear and tear of plant and buildings. Only 
a very small part of the entire product of the business 
reaches the owners of the business in the form of dividends ; 
the greater part has been needed to keep the business 
alive, because businesses wear out. A machine does exist 
at the end of the year apparently in the same condition as 
it was at the beginning of the year, but the sameness is 
only apparent. All through the year the machine has been 
wearing out. It has been growing obsolete, and out of the 
product of the machine the cost of this wear and tear has 
to be taken, and a sinking fund supplied to provide a new 
machine when the present one is obsolete. The machine is 
being " consumed," only we do not notice it because the 
consumption is so gradual. Even land, agricultural land, 
has not the permanence that we commonly attribute to it, 
because it loses its fertility and this fertiUtyhas to be restored 
to it. It continues to yield a crop only because some of the 
value of each year's crop has been put back into it in the 
form of manure and work ; and if this is the case with the 
land itself, much more obvious is it that the farm buildings, 
dykes, fences, etc., all wear out and have to be replaced 
before there is any net income received from the land. 



234 ECONOMICS chap. 

In a word, everything that we produce is consumed ; if the 
consumption is objectless we call it waste, but by deliberate 
use or waste everything is consumed. Usually the instru- 
ments of production wear out slowly, they are used many 
times. But it is not their greater durability that con- 
stitutes them capital, it is their use ; capital is not certain 
forms of wealth, but any form of wealth put to a certain 
use, namely that of assisting the production of further 
wealth. The manufacturer's loom is capital, because it is 
aiding labour on the production of cloth ; but the cloth 
on the tailor's shelves is equally capital, since it enables 
him to carry on his business, to give his customers what 
they want when they want it, without keeping them waiting 
while he orders it. Capital wears out or grows obsolete, 
and has to be replaced ; the capital of a company remains 
the same in apparent amount, only because this constant 
replacement from income is duly kept up. Land becomes 
exhausted, and has to be revived. Land and capital remain 
the same in the same way as the school-boy's knife is the 
same when it has had two new blades and a new handle. 
We are told that the substance of the human body is renewed 
completely every seven years ; in the same way the substance 
of the economic body of society is constantly being renewed ; 
land, labour, and capital produce, and out of their product 
they are renewed 

III 

Spending and Saving 

This constant decay and renewal is the explanation of 
the title given to this chapter, the circulation of wealth. 
If we think of society as a body and wealth as the blood, 
the agents of production are the heart, continuously taking 
in and giving out wealth. This regular renewal of tlie means 



xn THE CIECULATION OF WEALTH 235 

of production does not go on automatically; it requires con- 
tinuous effort and sacrifice, and the great volume of wealth 
required for this purpose is one reason why the flow of 
wealth, which can be annually distributed as wages, profits, 
and rent, is not larger than it is — one reason for the apparent 
discrepancy between society's income and its vast productive 
power. At any moment the productive capacity of society 
is limited by the amount of its capital, the natural riches 
and state of development of its land, and the number and 
efficiency of its population. It can always increase its 
productive capacity by increasing its capital, improving 
its land, or increasing the efficiency of its population ; 
but if it wants to use its current income for any of these 
purposes, it cannot use them for the satisfaction of current 
wants. 

Individuals and society have at every moment to 
decide how much of their income, how much of the 
productive capacity at their command, shall be devoted 
to aiding future production. That part of income that is 
devoted to aiding future production is said to be saved. 
That does not mean it is not spent or consumed ; it means 
that it is spent or consumed to aid further production. If 
the income has been received in cash, the saved portion is 
put in a bank and the bank lends it to business men who 
use it to aid their work of production ; or it is invested ; 
that is, the owner puts it into a business which uses it to 
buy buildings, plant, materials, etc. We may put the case 
concretely by saying that " savings " constitute a demand 
for buildings, machines, materials, and stock-in-trade, 
while the rest of income is a demand for food, clothing, 
shelter, and other goods and services for immediate consump- 
tion ; both are spent, but the object of spending is different 
in the two cases. 



236 ECONOMICS chap. 

If the •wealtli of a country is to be maintained, tlie 
depreciation of capital, the repairs and renewals of land, 
and number and efficiency of its workers must be kept 
up out of its gross income. Business men recognise 
this when they speak of the danger of " driving capital 
abroad " by oppressive taxation. The machines and 
buildings at present in use as capital cannot be exported ; 
but the income derived from these machines and buildings 
can be applied not to repairs and renewals of them, and 
additions to them at home, but to the establishment of 
new factories abroad. Similarly, land may be neglected, 
and give a decreasing income year after year. But the 
greatest danger to the future prosperity of a country is 
the neglect of its workers. Underfed, badly housed, ill- 
educated, or casually employed workers give inefficient 
labour, and these ill efiects are cumulative, since the present 
generation is largely responsible for the quahty of the next. 
Similarly oppressive legislation, or the absence of legislation 
to prevent oppression, which to-day is a greater danger, will 
drive labour out of the country. The growth of England's 
manufactures before the Industrial Ee volution was greatly 
helped by the immigration of Flemings and Huguenots 
who were driven from their native countries, and England's 
gain was the other countries' loss. Social inequahties may 
have the same effect as oppressive legislation. There is no 
doubt that the English working man of enterprise and 
energy has better prospects in the Dominions and the 
United States than he has at home ; hence the constant 
exodus from England of emigrants, who, discontented with 
their prospects at home, go to contribute to the wealth 
of countries where the career open to talents is nearer 
realisation. 



xii THE CIRCULATION OF WEALTH 237 

IV 

The National Dividend or Income 

Because wealth is a " flow," a country can always pay 
for new goods and services ; there is always a demand for 
additional labour, capital, and land ; there is always room 
for new inventions and improvements in organisation. This 
assertion may seem strange when we are constantly hearing 
of capital seeking investment, land lying idle, and, above 
all, labour unemployed. It is perfectly true that capital, 
land, and labour are often unemployed ; but the reason 
for their unemployment is certainly not that the income 
of the country is fixed and limited, so that any labour- 
saving device, whether machinery or better organisation, 
must permanently displace some of the labour and capital 
at present employed ; there may be a temporary displace- 
ment, and some workers may sufier, but in the long run 
the introduction of " labour-saving " machinery increases 
the demand for labour. 

Let us work out an example. A boot manufacturer, 
employing a hundred hands, introduces a machine which 
enables him to produce with seventy-five hands as many 
boots as before ; what happens ? He may decide to 
produce more boots and keep on his hundred hands ; 
if he makes more boots, he will have to sell them at a 
lower price — as presumably he can do, thanks to his new 
machines — or the market will not take them. The net 
effect in that case is that no labour is displaced, additional 
labour is required for making the machines, and some people 
who could not afford his boots before can afford them now. 
But suppose he does dismiss twenty-five hands. The 
additional demand for labour to make the new machinery 



238 ECONOMICS chap. 

still remains, but that is not equivalent to the falling-ofi 
in the demand for labour in the boot factory. The true 
equivalent is foimd in the increased demand which the 
manufacturer makes for labour owing to his increased 
income. His expenses of production are less, he has as 
many boots as before to sell, therefore his income will be 
bigger. He will spend the increase or " invest " it ; if he 
spends it, it constitutes a new demand for the labour 
required to make the things he wants ; if he invests it, it 
constitutes a new demand for the labour required for 
the machines, buildings, etc., of the business iii which he 
invests it. 

In time, however, other manufacturers will adopt the 
new machmery, their competition will compel our manu- 
facturer to reduce his prices nearer the cost of production^ 
and his income will come back to its old dimensions. Corre- 
spondingly his demand for labour will fall, and we seem to 
have a net reduction in the demand for labour. But we have 
ignored the fall in the price of boots ; that fall has released 
so much of the income of all the people who buy this class 
of boots, and enables them to buy either more boots or more 
of something else j thus even if their demand for the labour 
of boot operatives has fallen, their demand for the labour 
of the operatives who make the other things that they buy 
has increased. If they decide, as is perhaps the most 
usual case, to buy more boots, then their demand for 
labour of all kinds remains the same as it was before. 
Provided; therefore, that the twenty-five boot operatives 
displaced by machinery can find out what will be wanted 
either by their employer, who now has a bigger income to 
spend, or by his customers, who, getting their boots cheaper, 
can buy something they could not afiord before, they will 
not be unemployed. 



xn THE CIKCULATION OF WEALTH 239 

It is something like this crude example that usually 
happens when " labour-saving " machinery is introduced. 
Usually the introduction is gradual ; often the new 
machinery is used only for a cheaper class of goods that 
was not made before. The output of the industry, intro- 
ducing the new machinery, will not remain stationary, 
and some of the hands — ^perhaps all — who would have 
been displaced if the output had remained stationary 
will be kept on to work the new machines. But if some 
are displaced, there will be an increase in the demand 
for labour in other industries owing to the increased purchas- 
ing power either of the employers in the industry or of its 
customers, or of both. If any workers are displaced, it 
will take them time to find new employment, and the new 
employment may be less remimerative than the old ; some 
of them who are old or highly specialised may be unable to 
find new employment at all ; but somewhere or other there 
is an increased demand for labour due to the introduction 
of " labour - saving " machinery. Distress Committees 
under the 1905 Unemployed Workmen Act- found that it 
was uncommon for an unemployed man to give the intro- 
duction of machinery as the cause of his unemployment; 
even more conclusive is the fact that while labour-saving 
machinery has been steadily increasing in., quantity for now 
over a century, and with increasing rapidity in the last 
forty years, there is no evidence that unemployment has 
increased or is increasing. The efiect of machinery on 
wages we shall examine elsewhere. 

Exactly similar is the case of the employment of people 
who are not dependent on their work for a living. The 
rich girl who decides to work for her living is not necessarily 
" taking the bread out of the mouth of " some one else. 
Suppose she takes a post as teacher at £120 a year ; her 



240 ECONOMICS chap. 

income is increased by £120 a year, she spends £120 a year 
more tlian she would otherwise have done ; there is £120's 
worth of demand for labour, capital, etc., more than there 
would have been if she had not begun to work. But what 
of the girl whom she has kept out of the post ? Would not 
she have earned £120 and offered the same demand for the 
goods and services of others ? True, and so long as she 
remains unemployed, the rich girl is displacing her ; but 
does she remain unemployed ? do we find as a matter of 
fact that as middle-class Englishwomen have forced their 
way into the professions and adopted the custom of working, 
the openings for poorer women have become less and un- 
employment among them greater ? We do not, because 
the income which these rich girls are now earning is an 
additional demand for labour of all kinds ; their work adds 
to the real income of society and therefore to the means 
that society has to pay additional workers. 

The case of the rich man's daughter is trivial, but 
it is exactly similar to an extremely important case, 
that of the addition to the population which a progres- 
sive society sees with every new generation. Every 
year in the United Kingdom 380,000 more human beings 
are born than die. That means that every year roughly 
380,000 more persons have to be made room for in 
industry and commerce ; employment and payment has 
to be found for nearly 380,000 new workers. Whence 
can this new employment and payment come ? Society 
is already spending or investing all its income, there 
are already unemployed workers. It can come from 
only one source, fi'om the new workers. There are 
380,000 people to feed, clothe and amuse — plenty of 
employment there ; and there are close on 380,000 more 
people producing and earning — a plentiful source of 



xn THE CmCULATION OF WEALTH 241 

payment there ! Additional textile operatives are needed 
to clothe the new population, building operatives to house 
them, farmers to feed them ; and the new population is 
these additional textile operatives, building operatives, and 
farmers. 

The National Income is not a fixed sum limiting employ- 
ment to a fixed number of workers. There is always room 
for an increase in production, whether that increase be 
due to a new and more efficient machine, the labour of 
hitherto unoccupied workers, or the more efficient organisa- 
tion of the workers already in employment. There is 
always a demand for this additional product, because the 
addition to society's income enables society to pay the 
additional workers or machines or organisers. In Dr. 
Marshall's words, the National Income or " National 
Dividend," as he prefers to call it^ " is at once the aggregate 
net product of and the sole source of payment for all the 
agents of production." What we call " Supply " and 
" Demand " are the same things looked at from the 
difierent standpoints of consumer and producer ; and 
consumers and producers are the same persons. The 
real National Income is the goods and services produced 
to satisfy the nation's wants ; it is these that land, labour, 
and capital produce, and it is with these that land, labour, 
and capital are paid : any increase in the product is an 
increase in the payments ; and the only reason why this is 
not obvious is that the separate producers exchange their 
product through the medium of money. Most people who 
receive an income contribute to production, either in their 
own persons by their work, or as owners of property which 
aids production. As producers they are highly specialised ; 
they want things they cannot produce themselves, and 
they obtain them by exchange. This exchange is the out- 

R 



242 ECONOMICS ckap. 

come of specialisation; and is the fundamental thing in the 
present economic organisation. 

It is only because our exchanges are made through 
money that we have any difficulty in perceiving that an 
increase in supply is (not " causes ") an increase in 
demand. If the community consisted of only four 
men, two farmers, a builder, and a weaver, and they 
exchanged their goods, then the weaver's supply of cloth 
would obviously constitute a demand for buildings and 
food, the builder's supply of buildings a demand for 
cloth and food, the farmer's supply of food a demand 
for buildings and cloth. The same products are both 
supply and demand, according to the point of view 
from which we are looking. In the modern complicated 
community the same is the case. The weaver's supply of 
cloth is exchanged by him for gold, and the gold then 
exchanged for buildings and food ; he sells cloth and buys 
buildings and food ; his demand for house room and food 
is due to and is proportionate to his supply of cloth. If he 
makes more cloth he can buy a bigger house and more food, 
or if he does not want a bigger house and more food, he 
can buy something else. Thus an increase in the supply 
of cloth is an increase in the demand for other things ; 
and vice versa, an increase in the supply of anything else 
may constitute an increase in the demand for cloth. What 
is divided among the members of society is the goods and 
services produced to satisfy its wants ; and the same goods 
and services are both Supply and Demand. 

This exchange is independent of the way in which the 
value of the product is distributed among the factors of 
production. Whether capital, land, or labour gets it, it 
is a demand for other goods ; because capitalist, worker, 
and laud-owner all spend their incomes. It is sometimes 



xn THE CIECULATION OF WEALTH 243 

suggested that the present economic system must come to 
an end because the workers do not receive in wages as 
much as they produce, so that they cannot buy back 
what has been produced. That, if true, is a very bad 
thing ; but it would not supply an explanation of unem- 
ployment. If the workers do not spend the whole price 
of the product, some one else does ; it is spent. Goods 
are produced to be exchanged, and exchanged they will 
be, whether by land-owner, capitalist, or labourer. 



CHAPTEE XIII 



UNEMPLOYMENT AND OVER-PRODUCTION 



Imperfect Co-operation between Specialists 

The sketch of economic society that was drawn in the last 
chapter is defective in one important respect. Society 
is made up of speciaHsed groups of producers, mutually 
dependent and engaged in the continuous exchange (through 
the medium of money) of their special products ; wealth 
takes the form of a continuous stream of goods and services, 
from which the means of production are constantly renewed 
and augmented ; new workers, new implements, new 
natural resources are constantly adding their contribution 
to the stream of goods and services, and by thac contribu- 
tion securing for themselves a place in the economic com- 
munity and a claim on the stream. The sketch did not, 
however, indicate how there comes to be any unemploy- 
ment ; how it comes about, in other words, that a system 
which regularly absorbs the new generation coming into 
industry every year is unable to absorb, however busy it 
may be, the whole of the workers who are wiUing and 
anxious to find work. Nor does it explain the regular 
recurrence of the related phenomenon, which we call, 
according to the point of view, over-production or under- 

244 



xm UNEMPLOYMENT AND OVER-PRODUCTION 245 

consumption. It would require a separate (and longer) 
work to deal witli these latter problems adequately ; all 
that will be attempted in this chapter is to show that they 
are not inconsistent with the account of the working of the 
economic system, given in the last chapter, and that they 
are connected with principles of the system which we have 
studied in earlier chapters. 

The principle on which the whole system is based is 
specialisation. Different kinds of labour, land, machinery, 
materials are all limited to one or a few uses, and in isolation 
are useless. The specialists must co-operate before they 
can produce anything of use. Whenever the co-operation 
is defective, the system will not work or will work badly. 
Specialisation without co-operation then is the first great 
danger to which the present system of production is exposed. 

A single fiim. is an organisation of specialised workers, 
specialised machines, specialised departments. In a well- 
organised and well-managed firm every worker, machine, 
and department co-operates harmoniously with every 
other ; all are fully occupied, without being overworked. 
But often the co-operation is not perfect ; one department, 
under-stafied or inadequately equipped, or for some other 
reason inefficient, will hold up several other departments 
at one time, and compel them to work overtime to make 
up arrears at another ; just as a single weak back will let 
down a whole football team. In the single firm there is 
a general manager, whose business it is to see that all the 
departments of the firm work together evenly and regularly. 
But co-operation between specialised firms in an industry 
is as important in modern industry as co-operation between 
separate departments in a firm, and there are no general 
managers of whole industries.' Weavers, spinners, wool- 
combers, wool-growers, and many others co-operate in the 



246 ECONOMICS chap. 

production of woollen fabrics ; their operations must have 
a certain proportion to one another, each stage of the 
industry must be adjusted to the wants and capacities 
of the other stages, or their co-operation will be defective. 
If the spinners expand their business more rapidly than 
sheep-farming expands, they will presently find that there 
is a shortage of material, which will bring in its train short 
time or unemployment for spinner's operatives, and also, 
though this is not a serious social problem, for spinning 
machinery. If the production of wool is increased and the 
manufacturers do not expand their plant in a corresponding 
degree, the spinners, though now able to get their material, 
will find themselves unable to dispose of their product, 
and there is over-production of yarn. By the time the 
manufacturers are ready to take all the yarn that can be 
produced, the spinners and wool-growers, discouraged by 
the difficulty they have found in disposing of their product, 
may have reduced production — which involves unemploy- 
ment or short time again for spinning-operatives and 
firms — and so a shortage of material for manufacturers and 
short time or unemployment for their operatives. Society 
relies on its organisers to secure the same co-operation 
between the different processes of one manufacture in the 
hands of different firms, as the general manager secures 
between the different departments of his firm, and the 
organisers often fail. 

Within a single industry such disorganisation should 
not be difficult to avoid ; in industry as a whole it 
occurs much more easily and frequently. An increase 
in the exports of certain manufactures may lead to 
an increased demand for ships to carry the exports ; 
the shipbuilding industry, responsive to this increased 
demand, enlarges its output. By the time the new ships 



xin UNEMPLOYMENT AND OVER-PEODUCTION 247 

are ready^ however, three years may have elapsed, and the 
need for the increased shipping have disappeared ; the 
result is a serious check to the shipbuilding industry. The 
difierent industries are one another's customers and 
colleagues ; an expansion of one, if it is not to be checked, 
calls for a corresponding expansion of others. But the 
different industries require different lengths of time for the 
delivery of their products. It is difficult therefore to ensure 
among them the harmonious co-operation which the modern 
industrial system requires. 

A great difficulty in the way of securing perfect co-opera- 
tion is the lack of mobility in the factors of production. 
There may be firms working below their full capacity for 
want of hands in one part of the country, while in another 
part men are on short time or unable to find employment, 
through some purely local cause, such as the bankruptcy 
of an employer. It takes time for the owners of the idle 
machinery and the owners of the idle hands to find each 
other ; the object of the Labour Exchange is to enable them 
to find each other with the least possible trouble and delay. 
Normally the needs of an expanding industry are met by 
an increasing proportion of the new generation going into 
it, but there are only the beginnings of a system of ascertain- 
ing where the new labour is wanted and directing the new 
generation in that direction ; boys and girls are constantly 
entering industries which will not want them in a few 
years. Again, the methods of industry are constantly 
changing. New processes, new materials, new machines, 
new markets, new systems of organising work, are con- 
stantly being adopted ; but labour, capital, and land are 
all specialised, and any change of method renders them if 
not useless, at any rate less useful, until they can be adapted 
to the new methods. This takes time, and while it is taking 



248 iECONOMICS cha#. 

place J there will be unemployment and other dislocation. 
The loss of value which skill and machinery suffer by such 
changes of method are a kind of bad debt which society 
must write off before striking a balance of the advantages 
of specialisation. 

II 

Imperfect Anticipation of Demand 

The second principle of the present organisation that 
bears on the problems we are stud}dng is the principle that 
production as a whole is carried on in anticipation of demand. 
Specialisation has been carried so far, and has resulted in an 
organisation so complex, that the production of most 
commodities begins many months before they are required. 
Individual firms may work to order or on contract, but that 
arrangement only shifts on to other shoulders the burden 
of anticipating what will be wanted. Whole industries 
may work to order ; the firms engaged in works of con- 
struction and engineering work almost entirely to order, 
and by varying their staffs to meet their requirements 
succeed in throwing the burden of meeting irregularities 
in the demand on to the shoulders least able to bear it, 
the shoulders of the workers. But these industries are 
engaged chiefly in supplying other industries with aids and 
facilities for production, and these other industries are 
working to meet a demand which has to be estimated, 
because the process of production must begin before it is 
expressed. The goal of most production is the retail 
counter, and the consumer expects to be able to get what 
he wants at that counter without giving notice beforehand. 
Production as a whole therefore is carried on on an estimate 
of demand. 

The demand for most things is fairly stable, and we saw 



xm UNEMPLOYMENT AND OVER-PRODUCTION 249 

in Chapter IV. that society has ways and means of estimating 
what demand is going to be. But mistakes are bound to 
be made. Things are made^ which, when made, are not 
wanted, or are not wanted so much as other things that 
have not been made. The co-operation between different 
specialists of the woollen industry may be perfect, and yet 
over-production of woollen goods occur, because the con- 
suming public, for whom the woollen industry works, 
prefer to spend their incomes less on woollens and more on 
other things. When we consider the variety of goods 
ready for sale in retail shops and the complexity of the 
organisation needed to produce each of them, and realise 
at the same time that that organisation has been brought 
into being and applied to the production of the goods 
without any expressed demand for them, it becomes matter 
for surprise, not that the productive organisation is occasion- 
ally misdirected, but that it hits its mark so often as it does. 
Let us be quite clear what we mean by over-production. 
It does not mean that more of the article has been produced 
than can be consumed or used ; it does not even mean that 
more has been produced than can be sold. Any quantity 
of a thing that has a use can be sold, if the price be put low 
enough. What over-production of an article means is that 
more of the article has been produced than can be sold at a 
price big enough to repay its makers the cost of production, 
plus sufficient profit to induce them to go on producing 
at the same rate ; all that has been produced can be sold, 
but only at a loss. The error may be in what the public 
wants ; a trifling error perhaps, as when a fabric is produced 
that fails to capture the fashionable public's taste, or a new 
form of amusement is provided that does not " catch on " ; 
or a serious error, involving the uneconomical application 
of large resources, as on a railway which, when completed, 



250 ECONOMICS chap. 

does not attract a sufficient density of traffic to make it pay. 
The important case, however, and the case which has most 
influence on trade fluctuations, is an error in anticipating 
liow much the public wants. The leaders of an industry 
may anticipate exactly what is wanted, but produce it in 
excess of the public's demand. The income of the public 
is limited ; it balances the satisfaction to be obtained from 
one thing against the satisfaction to be obtained from other 
things ; it can be induced to increase its purchases of a 
thing by a reduction in the price, it will usually restrict its 
purchases if the price is raised ; but at any price it will 
purchase only a certain amount of each thing, and if pro- 
ducers produce in excess of that amount they will be able to 
sell the whole of their output only by lowering the price. 

The absence of any central control of production encour- 
ages such over-production. Each of a number of competing 
firms may anticipate accurately how much the public will 
take at a given price, and yet over-estimate the proportion 
of the total demand which competition will allow him to 
secure. The result is that each puts on the market more 
than his fair proportion, and the total amount put on the 
market is greater than the public will take at the price 
which the producers counted on getting ; one of the great 
advantages of trusts and combinations is, we saw, that it 
lessens the risk of committing this error of anticipation. 

Whatever the kind of error, however, errors of anticipa- 
tion are constantly being made, and their effect is always 
the same, the defective adjustment of supply to demand. 
If the supply put on the market is greater than the demand 
for the commodity at the price on which producers counted, 
the producers will have to reduce their price if they wish 
to sell their whole output. If they reduce their price, their 
profits will be less than they anticipated, and they will 



xm UNEMPLOYMENT AND OVEE-PEODUCTION 251 

lessen production ; if they hold out for their price^ they 
will be unable to sell their whole output, and the market 
will be glutted ; in either case there is a check to production. 
If the error of anticipation is in the opposite direction, and 
less is put on the market than the market will take at the 
anticipated price, competition among buyers for this limited 
supply will force its price up, the higher price will yield 
profits higher than were anticipated, the higher profits will 
stimulate increased production, and the probability is that 
the relative scarcity will be succeeded by a relative excess, 
the stimulus to production by a check to production. The 
stimulus to increase production carries with it its own 
antidote, since the increase in supply will tend to force 
prices down and so check production. Similarly, the check 
to production brings about its own correction ; things 
continue to wear out and stocks continue to be consumed, 
although the supply of new stocks has been checked ; the 
time comes when the public has to buy, and when that time 
comes, the relative scarcity of the depleted supply enables 
the producer to get his price. 

To summarise, the price of a thing depends on the relation 
of the supply of it to the demand for it ; if the supply is 
relatively small, the price will tend to rise, and the higher 
price will stimulate increased production, until the supply 
equals or exceeds the demand ; if the supply is relatively 
large, the price will tend to fall, and falling prices check 
production, until the price rises again. Over-production 
and under-production occur because supply has to be 
adjusted to demand ahead of demand, on an estimate of 
it, not in response to an ascertained and definite demand. 
If the estimate is wrong, the price, on the basis of which 
production has been carried on, will not be realised, and 
the even flow of production will be dislocated ; it is the 



252 ECONOMICS chap. 

relation between the anticipated price and the realised price 
that matters. 

Ill 

Cyclical Trade Fluctuations 

Alternating over-production and scarcity, with their 
consequences, unemployment and overtime, can be put 
down in any single trade to the failure to anticipate demand 
accurately and adjust supply to demand evenly. Much 
more difficult to explain is the problem presented by the 
fact that over-production occurs, not in one industry at one 
time and in another at another time, but in ail or most 
industries at the same time. The circulation of wealth is 
subject to general fluctuations, the most marked symptoms 
of which are alternating periods of overtime and unemploy- 
ment. At one time producers in all trades cannot work 
fast enough to satisfy the demands of the market, employers 
in all trades cannot get the operatives they want ; at 
another time producers in all trades cannot find a market 
for the goods they are producing, and employers in all 
trades dismiss or put on short time their operatives. What 
is the cause of this general movement up and down ? 
Without pretending to offer a complete explanation, one 
or two suggestions may be put forward. 

The separate trades are one another's customers, so that 
depression in one affects the others. Producers are also 
consumers ; if therefore the producers in one trade are 
getting lower wages and lower profits, they can spend less 
on the products of other trades. Conversely, if one trade 
revives, it will influence other trades ; its members, since 
they are selling more, are able to buy more, and the im- 
proved demand for their goods and services is transmitted 
to other trades by their increased purchasing power. 



xm UNEMPLOYMENT AND OVEE-PRODUCTION 253 

This material bond between trades, however, is not 
enough to account for the rapidity with which depression 
or boom spreads from trade to trade over the whole field 
of industry. The connexion seems to be psychological. 
The leading men in all tradea are all looking ahead. Their 
estimate of future demand should be the result of a severely 
scientific balancing of evidence, backed by a specialised 
instinct born of long dealings with a certain market. To 
some extent it is that, but not altogether. Few men can 
resist the influence on their own opinions of the hopes and 
expectations of their associates. A market is a crowd, 
and has the psychological characteristic of the crowd, that 
the general opinion imposes itself on individual members 
with extraordinary force and rapidity. Hence if a strong 
opinion is started — no matter how — that trade is improv- 
ing, then that opinion will spread ; the most level-headed 
operators will be influenced by it. Manufacturers will 
increase their output and pay higher prices for materials 
and higher wages to get more labour, since they anticipate 
no difiiculty in selling their goods, and the market will 
take any amount. And so long as every one is of this 
opinion, trade will be good. Exchange goes on freely even 
at high prices, because the man who is buying at high 
prices is confident that, by the time he sells, prices will be 
higher still. Every trade, being busy, affords a brisk 
demand for the products of every other trade. 

In precisely the same way an opinion that demand is 
falling off will impose itself on the business community. 
The transition from the one state of mind to the other may 
be brought about by chance ; a leading firm may take fright 
and begin to cut prices before its competitors ; other firms, 
observing its action, follow suit, and other trades, observing 
the fall of prices and consequent slackening of production 



254 ECONOMICS chap. 

in the one trade, are shaken out of their optimism. A 
great bankruptcy may turn the current of opinion, however 
unrelated the failure of the particular firm may be to the 
general course of trade ; the slump that follows a war, a 
wet season, the death of a monarch followed by general 
mourning, may any of them, by aSecting one trade or set 
of trades, tm^n the tide. More usually it will be brought 
about not by chance but by the occiurrence, almost inevitable 
in the present system of production, of over-production in 
one or two trades, and opinion in them will infect opinion 
in industry generally. Once set in, the depression is 
accentuated by the refusal of sellers to lower prices. They 
hold out for the high prices which are now a thing of the 
past ; being unable to sell, they are unable to buy, and 
the circulation of wealth is checked until they give way. 
Improvement comes, in industry generally as in a single 
industry, when the consumption or wearing out of stocks, 
coupled with the checking of supply, forces prices up again. 
It is helped by the fact that people, being unable during 
the depression to live on Income, draw on savings and 
investments ; their savings being withdrawn from pro- 
duction, production is checked still further, and the rise 
in prices accelerated in consequence. Or production may 
be reduced by the weaker firms in each trade being unable 
to carry on business. 

This suggested explanation has been given more or less 
in the terms of the market ; to relate it to the sketch of 
industry given in the last chapter, it is necessary to eliminate 
the references to purchase, sale, and price, and to think of 
the transactions as exchanges of goods and services between 
groups of specialised producers — an aspect of them which 
the use of money as a medium of exchange conceals. From 
this point of view we should say that producers can always 



xin UNEMPLOYMENT AND OVER-PRODUCTION 255 

find consumers who will give them something in exchange 
for their products^ but producer and consumer cannot 
always agree on the terms of the exchange. The regular 
process of exchange is checked because the exchangers 
cannot come to terms ; and exchange being checked, the 
production of wealth for exchange is checked. In a simple 
community the terms of exchange can be settled before 
production is commenced, and much production is not for 
exchange at all ; hence there need be no misdirected 
production, and no over-production with consequent un- 
employment. In the complex modern community pro- 
duction has to be commenced long before the final exchange 
of products can be negotiated ; if the terms of exchange 
(the prices realised) disappoint anticipations, so that the 
organisers of production receive less in exchange for their 
products than they have expended in producing them, they 
will suspend or restrict production till they can get the terms 
they want. 

W. S. Jevons suggested another explanation for these 
fluctuations in trade. He observed that trade depressions 
recurred at fairly regular intervals ; he observed also that 
the spots on the sun reached their maximum at about the 
same interval. His theory is that the initial cause of the 
depressions was a falling ofi in harvests, especially in 
tropical harvests, due to the falling oS in the light and heat 
of the sun. Probably the physical cause contributes to the 
fluctuations ; it is hardly enough to account for them 
altogether, even if the statistical basis for the conclusion 
were adequate. Especially it does not explain why most 
trades are affected simultaneously ; the influence of a 
failure of tropical harvests would take some years to 
permeate industry. 

Two factors in the modern industrial organisation may 



256 ECONOMICS chap. 

accentuate booms and depressions — the credit system and 
what we have called illegitimate speculation. The place 
of credit in the organisation of production has been described 
in Chapter X. It is the chief source of the elasticity^ the 
responsiveness to demand^, of the modern productive 
organisation. In a time of optimism banks and allied 
agencies give credit easily to business men^ and so enable 
them to increase the amount of their business and to offer 
higher prices ; in times of waning confidence banks, by 
restricting advances, deprive business men of an aid that is 
essential if they are to carry on business on their usual 
scale, and they depress prices. A sudden restriction of 
credit may even drive some firms into bankruptcy, and so 
shake confidence that not merely financial depression, but 
general industrial depression ensues. Probably no class 
therefore can do so much to exaggerate trade fluctuations 
as the bankers ; a cautious and conservative policy in the 
giving of credit is essential to the stability not only of the 
banks and their allies, but of the whole industrial community. 
The present economic system is, in fact, too responsive to 
demand. The influence of the other factor, illegitimate 
speculation, will be inferred from what was said of it in 
Chapter IV. The honest dealer makes mistakes, and every 
mistake tends to accentuate price-fluctuations. The dis- 
honest dealer, who produces artificial price - fluctuations, 
does still more to accentuate them. The dealer, who 
deals on inadequate capital and makes a mistake, involves 
others in hia ruin. The outsider, ignorant of the market 
and the material dealt in, is much more likely to make 
mistakes than the professional dealer. Every kind of 
illegitimate speculation tends to accentuate price-fluctua- 
tions, and therefore to make more difiicult the task of 
anticipating demand and adjusting supply to it. 



XIII UNEMPLOYMENT AND OVEK-PRODUCTION 257 

The recurrence of over-production^ however, is connected 
with the fundamental principle of the present system of 
production, specialisation, with its outcome, production in 
anticipation of demand. It is the great weakness of the 
system, as a productive organisation, and its results are a 
heavy price to pay even for the wealth which specialisation 
enables society to produce. The loss and sufiering caused 
by trade-fluctuations are largely concentrated on the poor, 
and the sense of helplessness which unemployment brings 
to a man is an affliction of the spirit even heavier than 
the material loss that accompanies it. 



CHAPTER XIV 



VALUE 



Value and Price 



The general reader who opens a book on Economics is often 
puzzled by tlie great amount of space given to tlie Theory 
of Value. The reason is that the value of a thing is the rate 
at which it exchanges for other things, and in modern 
economic society almost all production is for exchange. 
The word " value " is in some respects an unfortunate 
term, since it is ambiguous. Take a few examples of its 
use — " the value of diamonds/' " the value of bread/' 
" the value of a kitchen garden/' " the value of prayer." 
Obviously it is not used in quite the same sense in all these 
examples. Yet there must be some common meaning in 
the different cases, or the same word would not be used. If 
we try to say what this common fundamental meaning is, 
we probably express it best by the word " usefulness " ; 
we attribute " value " to anything that has a use, anything 
that can satisfy a human want. But that is not the 
commonest sense in which we use the word. If we point 
to a house and ask its value, the answer we get will be given 
in pounds and shillings, and the commonest of all the 
senses in which the word " value " is used is to denote the 

258 



CHAP. XIV 



VALUE 259 



rate at which things exchange. It is in this sense that it is 
used in Economics ; a theory of value is an explanation 
of the rates at which things exchange. Adam Smith dis- 
tinguished between the two chief senses of the word by the 
phrases " Value in Use " and "Value in Exchange " ; modern 
economists use the word " Utility " to denote Value in Use, 
and keep the word " Value " for " Value in Exchange." 

Now the exchanges in which we are constantly engaged 
are not usually direct exchanges of goods for goods or 
services for services or goods for services — usually they 
take place through the medium of money. Since most 
exchanges are made in this way through money, money 
comes to be a general common standard of exchange rates, 
since everything is at some time or other exchanged for 
money ; the amount of money for which it is exchanged 
becomes an indication of its value when compared with 
other things. V aluer s a ratio ; for the sake of convenience 
the values of^pther things are expressed as ratios to money ; 
consequently we speak and think usually not of values but 
of prices, the price of a thing being the amount of money 
for which a thing exchanges. There are certain advantages, 
however, in keeping to the term " value " in examining 
the principles of exchange. We do not speak of a thing 
having a price unless it is for sale ; anything may be said 
to have a value whether it be for sale or not. Again, we 
feel that the price of a thing does not always represent its 
value. In the case of sale by a trick, or when one of the 
parties to a sale is under the influence of drink, price and 
value do not coincide ; such a phrase as " good value for 
money " is meaningless if price and value are necessarily 
the same thing. Such considerations are not important, 
prices are fairly representative of values at any given time ; 
but when we compare one time with another, for reasons 



260 ECONOMICS chap. 

explained in Chapter XL, a change in price is no evidence 
of change in value. 

This possession of a general common measure of values 
in money is an enormous help in studying them. At 
first sight it might seem impossible to compare the values 
of such different things as a surgeon's skill, an ounce 
of tobacco, a preacher's eloquence and a loaf of bread ; 
yet, as a matter of fact, we do compare them. They are 
compared and measured and priced ; and if we are rational 
beings they are priced on some principle, their values are 
not fortuitous. Their qualitative differences are reduced 
to quantitative differences ; our individual estimates, our 
motives, are measured by the price we are willing to give 
for each.; Moreover, if we can take prices as representative 
of values, we have got facts to start with. " A price is a 
fact. A value is an estimate of what a price ought to be " 
(Hadley). The price of a thing is a known thing, the same 
for every one — there can be no dispute about it ; the value 
of the same thing might be estimated differently by different 
people, their estimates varying with their moral and intel- 
lectual standards. 

Again, though prices are somehow or other the outcome 
of our estimates of the relative importance of things, they 
undoubtedly react strongly on our estimates. We are so 
used to associating high price with high quality that we 
sometimes refuse a good thing because its price is low. 
Furniture, clothes, hotels and entertainments are often 
deliberately made expensive in order to attract a certain 
class of buyer whose only criterion of quality is price. 
Especially does price influence social judgments : in 
England and America a man's social rank is determined 
chiefly by his price or " income." The usage of ordinary 
speech convicts us of this snobbishness, since we say a man 



XIV VALUE 261 

with an income of £10^000 a year is " worth " £10^000 a year, 
though morally he may be " worthless." 

Prices then roughly measure values for us, but in making 
our study of the causes which settle the rates at which 
things exchange for one another, we prefer the wider term 
value to the narrower term price ; we aim at formulating 
"a theory of value," "a theory of prices " being quite 
another thing. What is the explanation of existing values ? 
why is a woollen shirt worth twice as much as a cotton 
' shirt ? — questions such as these constitute the Problem of 
Value. 

II 

The Labour Theory of Value 

There have been three theories of value of historical 
importance — the Labour Theory, the Cost of Production 
Theory, and the Marginal Utility Theory. The three 
theories have a common starting-point ; they agree, to 
quote Mill, that " the temporary or market value of a 
thing depends on the demand and supply ; rising as the 
demand rises and falling as the supply rises." But, Mill 
goes on, " besides their temporary value, things have also 
a permanent value, or, as it may be called, a Natural Value, 
to which the market value, after every variation, always 
tends to return ; and the oscillations compensate for one 
another, so that, on the average, commodities exchange 
at about their natural value." It is about this permanent, 
normal, or natural value that the theories differ. In this 
chapter we shall be concerned with the two first theories, 
which approach the problem from the side of supply, in 
the next with the Marginal Utility Theory, which approaches 
it from the side of demand. 



262 ECONOMICS chap. 

Tlie chief exponents of tlie Labour Theory are Adam 
Smith, Eicardo and Karl Marx. They hold that the value 
of a thing, in the long run, depends on the amount of labour 
embodied in it. " It is natural/' says Adam Smith, " that 
what is usually the produce of two days' labour or two 
hours' labour should be worth double what is usually the 
produce of one day's or one hour's labour." Eicardo 
speaks of labour " as being the foundation of all value, and 
the relative quantity of labour as almost exclusively 
determining the relative value of commodities." Marx 
puts the same simple theory in more difficult language ; 
when we have abstracted all the individual qualities and 
properties from commodities, " the residue . . ./'he says, 
" consists of the same unsubstantial reality in each, a mere 
congelation of homogeneous human labour, of labour power 
expended without regard to the mode of its expenditure. 
. . . When looked at as crystals of this social substance 
common to them all [commodities] are — Values." Else- 
where he says " the value of a commodity is determined 
by the quantity of labour expended dming its production." 

The holders of this theory recognise that a commodity 
must have utility, or use-value, to possess exchange-value, 
but they cannot see that the utility of a commodity has 
anything to do with fixing the amount of its exchange- 
value, Adam Smith points out — the paradox of value — 
that goods with the greatest use-value have often a low 
exchange-value, while such things as diamonds with a high 
exchange-value have only a low use-value ; while Marx 
thinks that because the utilities of different commodities 
are different we cannot look to utility for a standard or 
basis of comparison for goods of different values. " As use- 
values/' he says, " commodities are, above all, of different 
qualities, but as exchange-values they are merely different 



XIV VALUE 263 

quantities, and consequently do not contain an atom of 
use-value." The theory allows also for the use of capital : 
machines and other forms of capital are " saved up labour " 
which is passed on to, and helps to determine the value of, 
the goods in the manufacture of which they are used. The 
greater influence which Smith and Ricardo allow to capital 
distinguishes their theory of value from that of Marx, and 
makes it approximate to the Cost of Production Theory. 

There is undoubtedly a general correspondence between 
the amount of labour required to make a thing and its value, 
and competition among sellers tends to beat down value 
to cost of production, which, on the view of capital given 
above, is equivalent to the cost in labour. When an 
invention " saves labour " in the making of a thing, the 
thing's value usually falls. The theory is attractive also, 
because it seems just that the value of a thing should be 
fixed by the trouble or labour involved in making it. There 
are, however, great difficulties in the way of accepting the 
theory as an explanation of existing values, and its simplicity 
disappears on closer examination. The chief difficulties 
are difficulties also of the Cost of Production Theory, and 
had better be deferred until that theory has been stated ; 
there is, however, one difficulty peculiar to the Labour 
Theory, namely the meaning of the phrase " amount of 
Labour " ; that we will deal with now. 

Like so many of the terms which Economics has to take 
from ordinary speech, " Labour " has no single, definite, 
well-understood meaning. Do the upholders of the Labour 
Theory mean by " Labour " only manual labour ? The 
use to which the theory is sometimes put implies as much. 
If so, they are ignoring the labours of organiser and inventor, 
which undoubtedly play a great part in the fixing of values. 
Again, within the province of manual labour, how do they 



264 ECONOMICS chap. 

compare skilled and unskilled labour ? To what common 
measure do tliey reduce kinds of labour so different as the 
navvy's^ the spinner's, the moulder's, the grinder's ? In 
the case of the same kind of labour, what do they take as 
their standard ? — for labour is not usually performed with 
equal efficiency by different labourers ; often the most 
valuable things, especially in art and handicrafts, are made 
with least labour, since they are the work of workmen of 
special talent or genius, and in every trade the best workman 
is the man who can effect most with least effort — just as 
that batsman usually makes most runs whose strokes are 
least laboured. 

The writers we have quoted are conscious of these 
difficulties and attempt to meet them. "It is not very 
easy," says Smith, " to find any accurate measure either 
of hardship or ingenuity. In exchanging indeed the 
different productions of different sorts of labour for one 
another, some allowance is commonly made for both. 
It is adjusted, however, not by any accurate measure but 
by the higgling and bargaining of the market according to 
that sort of rough equality which, though not exact, is 
sufficient for carrying on the business of common life." 
Thus, though the value of a thing depends on the amount 
of labour in it, the amount of labour with which we must 
credit it is settled by the higgling of the market, in other 
words, by our old friend Supply and Demand, Eicardo 
ignores the difficulty. " The estimation," he says, "in which 
different qualities of labour are held comes soon to be 
adjusted in the market with sufficient precision for all 
practical purposes, and depends much on the practical skill 
of the labourer, and intensity of the labour performed. 
The scale, when once formed, is liable to little variation " — 
which is true, but does not explain wliich kind of labour 



XIV VALUE 265 

he means when lie speaks of the " amount of labour " 
determining value. 

Marx tries several explanations. At one time he 
says : " The quantity of labour however is measured 
by its duration^ and labour time in its turn finds its 
standard in weeks^ days and hours/' — which, if true, 
would make it profitable to employ unskilful workers, 
since by taking longer over their work they would produce 
more value. In another place he takes unskilled labour 
as his standard : " We shall henceforth account every 
kind of labour to be unskilled, simple labour " ; in another 
place " average " labour : " The labour time socially 
necessary is that required to produce an article under the 
normal condition of production, and with the average 
degree of skill and intensity prevalent at the time " — i.e. 
the length of time actually spent by the labourer in produc- 
ing an article has nothing to do with its value — its value 
depends on the amount of " socially necessary labour " 
that the worker succeeded in putting into it. Finally Marx 
adopts " simple, abstract, human labour " or " socially 
necessary labour" as his standard. He is not, however, any 
more successful than Adam Smith in explaining why we 
must credit an hour's work of a cotton spinner with two 
and a half times as much " socially necessary labour " 
as an hour's work of a farm labourer ; all he can say is that 
" the different proportions in which different sorts of laboiu: 
are reduced to unskilled labour as their standard, are 
established by a process that goes on behind the backs of 
the producers, and consequently appears to be fixed by 
custom." This is no reason why it should "go on behind 
the backs of " economic students. What this unseen 
process is, is indicated by Mr. Hyndman, Marx's chief 
English exponent, who says : " The quantity of labour 



266 ECONOMICS chap. 

incorporated is determined not actually^ but relatively in 
equivalence with definite quantities of other commodities. 
This equivalence and therefore the social minimum of time 
required for production being determined by competition 
and the higgling of the market." 

The argument; though a little more round-about, has 
brought us to the same goal as Adam Smith's argument : 
value depends on the amount of socially necessary labour 
in a thing, but the amount of socially necessary labour in 
a thing can only be settled by bringing the thing into the 
market and seeing for how much of other things it will 
exchange ; but the rate at which it exchanges for other 
things is its value, so that all the argument has proved 
is that Value depends on Value. There is no unit or 
measure of labour which we can use as a standard of 
value ; " simple abstract human labour " is a perfectly 
justifiable concept, but then so also is " simple abstract 
human utility." There is no greater difierence in kind or 
quality between the utility of a table and the utility of a 
tea-pot than there is between the labour of a cabinet- 
maker and the labour of a potter. To say that labour is a 
very important element in the influences that fix values is 
true and important, but to exclude all other influences and 
attempt to make labour a standard of value leads inevitably 
to argument in a circle. 

Ill 

The Cost of Production Theory of Vahie 

The other explanation of value that approaches the 
problem from the side of supply is the Cost of Production 
Theory. It differs from the Labour Theory only in allowing 
for other elements besides labour in the cost of producing 



XIV VALUE 267 

a thing, especially in allowing for profits, the remuneration 
of the capitalist. " The cost of production/' to quote Mill 
again, " together with the ordinary profits, may be called 
the necessary price or value of all things made by labour and 
capital." This conclusion is reached by observing the 
effects of competition : if the value of a thing rises above its 
cost of production, its makers receive more than the average 
rate of profit, high profits attract more labour and capital 
into the trade, and the competition among sellers to sell 
the increased supply brings the value of the thing down ; 
if the value of a thing falls below its cost of production, 
some of its makers reduce their production, or leave the 
trade, so that the supply is reduced, and buyers competing 
for the reduced supply force the value up again. In certain 
cases cost of production varies from producer to producer — 
owing, for instance, to variation in the fertility of land or 
in proximity to markets ; to meet such cases the rule was 
restated, and value said to depend on " cost of production 
under the most disadvantageous existing circmnstances." 
The amount of a crop that society wants cannot be supplied 
from the best land alone ; inferior land has to be brought 
under cultivation. The cost of production on the inferior 
land is greater than on the good land ; society has to pay 
a price high enough to cover this higher cost of production, 
or it will not be able to get as much as it wants, and all the 
producers are able to get this price. 

Whichever form a theory takes that attempts to explain 
value from the side of supply, it has certain difficulties to 
face. First of all it ignores the possibility of misdirected 
labour. Labour and the other elements in the cost of pro- 
duction are constantly being applied to the production of 
commodities that possess, when made, little or no utility ; 
a large part of the organisation of production is concerned 



268 ECONOMICS chap. 

solely with facing and averting this danger, and, as we have 
seen, failure is frequent. The cost of production of a suit 
that, when finished, does not fit, has nothing whatever to 
do with its value. An English municipality a few years ago 
built a reservoir embankment on an insecure foundation ; 
its cost of production was £200,000, its value nothing. It 
is no answer to this difficulty to say, as Marx says, that 
the labour embodied in products of no utility " does not 
count " ; cost of production cannot be recovered if the 
thing produced turns out to be useless. AVhat has cost of 
production to do with the values of summer hats at the end 
of the summer season, or of winter fashions at the spring 
sales ? If it be urged that such cases are abnormal, one 
can only reply that they are of everyday occurrence. A 
country in which the cost of production invariably fixed 
the value of a thing would be a business man's paradise, 
because he would never be punished for his mistakes ; we 
ignore half our problem if we take utility for granted. 

Similarly this group of theories does not explain changes 
in the value of a thing after it is made. Cost of production, 
whether measured in labour alone or not, is something 
settled and definite once a thing is produced — it belongs to 
the past and cannot be changed ; but values do change. 
So far as there is change in methods of production, it may 
be said that the cost of production, or the socially necessary 
labour embodied in a thing, can change even after the 
thing has been completed ; but values change when there 
has been no change in methods of production. A death in 
the royal family will destroy the value, for that season at 
any rate, of whole stocks of dress goods ; house property 
declines in value in a " decayed " neighbourhood without 
any change in the methods of building houses : the gross 
annual value of lands in England (as returned under Schedule 



XIV VALUE 269 

A of the Income Tax) fell from forty-eiglit and a half 
million pounds in 1879 to thirty-seven million pounds in 
1893. Similarly values rise irrespective of cost of produc- 
tion. Building sites in great towns are the most obvious 
case, shares in successful joint-stock companies are another 
— the value of a company's buildings, plant and materials 
depends not at all on their cost of production, but on the 
demand for the goods which the company makes. Such 
cases are far too numerous to be dismissed as " exceptions " 
or with the statement that " in the long run " cost of 
production determines value. 

Still less will any Cost of Production Theory explain 
the " scarcity " values of works of art, favourable building 
sites, exceptional ability, etc. What of " dumped " goods ? 
Dumping is merely the application of the principle of 
spring sales to foreign trade. How, again, can railway 
rates be explained on the Cost of Production Theory ? 
The conclusion to which a study of Cost of Production 
theories of value leads us is that demand and utility, 
somehow or other, play a very important part in fixing 
values ; where value and cost of production or amount 
of labour do correspond, it would be just as true to say 
that the value of the thing decided how much labour, 
etc., shall be devoted to producing it, as to say that the 
amount of labour, etc., fixed its value. 

An analysis of the action of the seller will lead us to the 
same conclusion^ How does the business man settle the 
price which he charges for his goods ? On what does the 
price he charges us depend ? Can he charge anything he 
likes ? Does he, as a matter of fact, fix his price by calcu- 
lating the total cost of production and then adding, say, 
10 per cent for his profit ? 

If the business man is not one of the leading men in the 



270 ECONOMICS chap. 

trade, if he cannot know with accuracy what the demand 
for his goods will be, or if he is doubtful about selling them 
at all, he probably will calculate the cost of them to himself, 
add something for his profit, and put them on the market 
at the resulting price. He will reason that his competitors 
will have costs of production about the same as his own, 
that they will want the same profit, and that they will be 
willing to sell at this price if he is not ; at the same time he 
cannot afiord to take a lower price, even if some of his 
competitors, with lower costs of production or a bigger 
turnover, can afford to. Taking business as a whole, 
however, this is not the invariable procedure. In retail 
trade stocks have sometimes to be cleared by " sales " 
for what they will fetch, or " leading lines " will be sold 
below full cost to attract customers ; in wholesale trade 
goods are often sold below full cost if the seller cannot sell 
them at any better price. 

Cost of production is a term that will bear more 
than one interpretation. A manufacturer will not sell 
below prime cost unless he is forced to realise some of 
his property by some sudden need for cash ; but he will 
often sell goods at a price that, after covering prime 
cost, makes only a small contribution to his standing 
expenses rather than let his works stand idle or allow 
competitors to cut into his market. Further, cost of 
production per unit varies with output : a producer will 
often quote a price for a large order below his present cost 
of production,, because he calculates that on the larger out- 
put his cost of production per unit will be smaller. Apart 
from this consideration, cost of production varies from 
firm to firm, fi"om district to district : the efficient producer, 
who by successful organisation can produce cheaper than his 
competitors, will not hand over the whole of his savings to 



XIV ■ VALUE 271 

the consumer in reduced prices — he will charge the highest 
price that the competition of other sellers will allow him to, 
and cheerfully pocket the big margin between cost of pro- 
duction and price that his cheap production leaves him. 

Again, there are cases where the exact cost of production 
of any single piece of work cannot be calculated. The cost 
of running an extra excursion train on a railway, the cost 
of taking a return freight on a steamer that would otherwise 
have had to return in ballast, the cost to the doctor, lawyer 
or stockbroker of any extra professional services, are cases 
in which prime cost can be calculated but total cost or 
real cost cannot : the railway has to be built and staffed 
to run even a single excursion train, the fares of the excursion 
ought to contribute to the expense of building and staffing 
it, yet all that expense would have been incurred even if 
that particular excursion train had not been run ; the 
steamer had to be built and equipped before it could under- 
take any freight at all, and every freight it takes ought to 
contribute to the cost of building and equipping it, yet the 
steamer was coming home without the return freight if 
it had not got it ; the professional man must have had his 
expensive training before he can undertake any professional 
services at all, yet once he has got the training an additional 
professional service makes practically no difference to his 
expenses. In such cases, then, the only possible principle 
on which the seller can proceed in fixing rates and prices 
is the railway company's principle of " charging what the 
traffic will bear." 

Those producers who have any influence on the fixing of 
price usually do one of three things. First, they may work 
to order : a customer offers to take a certain quantity 
at a certain price ; the producer finds that his cost of 
production for that quantity is less than this price, and 



272 ECONOMICS chap. 

takes the order ; lie does not tell his customer what his 
cost of production is — though he often tells him that the 
things " cannot be produced at the price." Or secondly, 
if the producer is not working to order, having made or 
arranged to make a certain quantity, he fixes the highest 
price for it that he thinks he can get — subsequently raising 
or lowering it according to the state in which he finds the 
market, perhaps also varying his price from customer to 
customer so far as he can do so without being found out ; 
the farmer, who has not complete control over the quantity 
of his output, has to adopt this procedure. Or thirdly, the 
producer may fix the price of his article first, and then 
make as much of it as he thinks will sell at the price ; a 
publisher, for instance, having decided to publish a book 
in a certain form at 6s., has to decide whether he will 
publish an edition of one thousand, five thousand, or what- 
ever other number is usual. But whichever of these three 
courses the producer adopts, there is one rule that, so far 
as he is influenced by business motives, he invariably 
obeys : he gets what he can, he acts on the railway company's 
principle and " charges what the traffic will bear." The 
only difference between the railway company and most 
other producers is that other producers can estimate much 
more exactly than the railway company can what is the 
true and full cost of each piece of work, and they are much 
more subject to competition. They do not, ho^vever, on 
that account fix their charges at cost of production ; they 
calculate cost of production carefully and take it as a 
minimum below which they will not let prices fall, and the 
competition of other sellers usually keeps them somewhere 
near that minimum ; but they get the highest price they 
can. 

It is only the leading men of each trade who have 



XIV VALUE 273 

much to do with the fixing of prices ; the great majority 
of sellers have to take prices for granted, producing as 
cheaply as they can and selling at the market price. In 
many industries, especially at the retailing end, there are 
traditional or customary prices, and what producers do is 
to vary the quality of the article which they will supply 
at the customary price — which comes to the same thing 
as varying the price of an article of standard or customary 
quality — or else they vary the quantity they will produce 
at the price ; in these variations, however, a few usually 
lead, the rank and file of the trade follows. 

IV 

Decreasing, Increasing and Constant Cost 

Our analysis of the action of the seller, then, supports 
the conclusion of our previous argument, namely, that 
value cannot be explained from the side of supply alone. 
It also forces on our attention another consideration. The 
phrase " Cost of Production " — like the word " Labour " 
— conceals more difficulties than it explains. It is con- 
stantly used as if costs of production were always simple, 
fixed and easily ascertained. This may have been the case 
once, but it is so no longer. Since the cost of production 
of anything is the chief element in determining its supply, 
we must try to get clear to ourselves the meaning of the 
phrase. 

Let us consider the elements in the cost of production 
as they present themselves to a modern manufacturer, and 
then consider the eiiects of a change in the volume of out- 
put. The first element is the cost of material ; this can 
usually be ascertained with accuracy, though even here 
if many different materials are combined in the fiziished 

T 



274 ECONOMICS chap. 

product the task is not easy. Next there is the cost of 
labour ; a large part of workshop management consists in 
devising means for ascertaining exactly what expenditure 
in wages is incurred on each piece of work done, and, if 
the commodity in its making passes through a great many 
hands, the task is very complicated. If we add to materials 
and labour any other expense that can be definitely 
attributed to the given piece of work, we have what has 
been called the " Prime Cost " of its production. Prime 
Cost, however, is never the total cost, and is often only a 
small part of the total cost of producing a commodity. 
Certain " Supplementary " or " General " or " Overhead " 
Expenses must be incurred to make it possible for the 
commodity to be produced. The firm must be organised, 
foremen and managers paid, whether much work or little 
is being done. Rent and wear and tear of buildings and 
machinery, the expense of the power plant, insurance 
against fire and accident, taxes, are all necessary expenses, 
but none of them can be allocated to any particular unit 
of the whole output ; office expenses and the expenses 
of the selling organisation are largely independent of the 
amount of work done. Thus we have to include in the 
full cost of production of each article produced not only 
the cost of material and labour, but a proportion also of 
the general expenses of the firm, and that proportion will 
vary with the number of articles produced. In most big 
manufacturing firms the estimation of the cost of production 
requires the whole time of a specialised " costs " depart- 
ment. 

Similarly if we wish to arrive at the exact expense to 
society of the production of any commodity, we have to 
add together its Prime Cost of Production to each of the 
firms that handle it, a proportion of their General Expenses, 



xrv VALUE 275 

the Prime Cost of transporting it and the materials of which 
it is made, and a proportion of the General Expenses of the 
different transport agencies, and a proportion of the expenses 
of all the merchants, bankers, shopkeepers and others 
who assisted in the collection, forwarding and exchange 
of the materials and finished commodity. Dentists in 
presenting their accounts to clients, after stating the total 
amount of their charge, sometimes add, " Details if 
required " ; if we were to ask for the details of all the 
payments for labour, materials, etc., that make up the 10s. 
we were charged for our woollen shirt, we should be setting 
accountants a complicated task to perform. 

Bearing in mind the distinction between Prime Cost and 
Total Cost, we will examine the efiect on Cost of Production 
of increasing the volume of production. There are three 
possible effects : the cost per unit may decrease, increase, 
or remain constant. In industry an increase in the volume 
of production (whether in the single firm or in the trade) 
usually brings with it a decreased cost of production per 
unit. There are two reasons for this. The first is that an 
increase in the volume of work makes it possible to carry 
specialisation further — labour, machines, management can 
all be specialised further in the fixm, while in the trade 
transport and marketing facilities can be specialised further, 
and subsidiary industries developed. The decrease in 
cost per unit owing to this cause will not be regular or 
continuous ; the cost will come down in steps, as it were, 
a drop taking place when a new machine, a new system 
of workshop organisation, a new method of distribution, 
or a new use for a bye-product becomes practicable. And 
the decrease has a limit ; in the firm it is limited by the 
ability of the management ; in the trade it is liable to be 
counteracted by increasing cost of raw material. The 



276 ECONOMICS chap. 

other reason for the decrease in cost that comes with an 
increased output is that the general^ standing or overhead 
expenses can be spread over a greater number of units 
of product. 

In the extractive industries — agriculture, mining and 
fisheries — an increased output cannot usually be obtained 
at a decreased cost per unit, unless some improvement in 
methods of production is discovered. The two economies 
we have described do not operate so strongly as in industry, 
and are liable to be counteracted by the niggardliness of 
nature. The most convenient or fruitful lands are naturally 
occupied fijst, and if an increased supply is wanted, recourse 
must be had to inferior or less convenient soils. If the 
attempt is made to raise more by putting more work or 
capital into the land, the additional product will be raised 
only at an increased cost, so long as technical science 
remains the same ; if we could always double the produce 
of our land by doubling our expenditure on it, we could 
raise all the food of the country on a single acre of land by 
doubling often enough. We do not feel the efiects of this 
niggardliness of nature only because invention is constantly 
postponing its pressure. In some industries also increased 
supply can be secured only at increasing cost ; in telephone 
service, for instance, an increased number of subscribers 
brings with it a more than proportionate increase in the 
complexity of the organisation, and consequently in the 
cost of working. Transport in great centres of population 
has often, though for different reasons, to face the same 
difficulty. 

The third case, the case of constant cost, will occur when 
the influences making for economy are just counterbalanced 
by the difficulty of getting more raw material or by the 
increasing complexity of the business. It is also the rule 



XIV VALUE 277 

with simple handicrafts^ in which general expenses are un- 
important. When handicraft was the rule, labour was the 
only important cost in production, and, since methods of 
industry and demand changed only slowly, the most 
important influence in fixing values. 

Costs of production, then, are neither simple nor fixed ; 
our examination of them will help us to understand the 
influence of cost of production on value. The distinction 
between Prime Cost and Total Cost explains why producers 
are often willing to sell a portion of their output at a price 
which does not cover the total cost of production. A 
heavy steel works, for instance, has very high standing 
expenses ; if it can recover the greater part of these standing 
expenses by selling a portion of its output at a high price 
(for instance in a protected market), it will pay it to sell 
the rest of its output for a price much below its total cost 
oi production, provided the price covers the prime cost, 
rather than not sell it at all. In times of trade depression 
it may lose less by selling its whole output at less than 
total cost of production, provided the price more than covers 
prime costs, than by letting its works lie idle ; in cases 
where the standing expenses bear a high proportion to the 
prime costs, selling at a loss in this way may go on for years. 
In some industries the Prime Cost of any single commodity 
or service is so small in proportion to the Total Cost that 
cost of production affords no help at all to an understanding 
of the price charged. Such is the case with railways, 
water works and, in a less degree, gas works. In each 
case an enormously expensive plant has to be kept in working 
order, and interest earned on the cost of it, whether much 
or little business is done. In the case of railways the cost 
of constructing the system is as much as ten times the 
annual receipts, and of the annual expenses 80 per cent 



278 ECONOMICS chap. 

have to be incurred independently of the amount of traffic. 
Under such circumstances it is impossible even for the 
management to say with any accuracy what is the true 
cost of running a particular train or carrying a particular 
consignment of goods ; the fuel^ wear and tear and wages 
can be calculated ; beyond that^ any estimate of cost must 
be more or less arbitrary. The prime cost is the only 
additional expense to the company for which this particular 
piece of work is responsible^ but on its traffic as a whole 
the company has to charge standing expenses amounting 
to 80 per cent of its whole expenses^ and in addition any 
interest paid on the capital invested in the railway. 

The consideration that there are usually different costs 
of production (per unit) for different amounts of a com- 
modity is even more important. It helps us to understand 
the constant movement of prices. If a single manufacturer 
in a trade in which decreasing cost is the rule lowers prices, 
the rest must follow suit ; the lower price at which he offers 
the goods would otherwise attract his competitors' customers 
to him, and he can make a profit at the lower price since 
his larger output enables him to produce cheaper. As 
soon, however, as the available supply of raw material 
falls short, and — failing new inventions — the industry has 
to resort to less productive sources of raw material, the 
price has to go up, or the producers will not be able to keep 
their businesses going. 

When, therefore, we speak of supply, we must be quite 
clear whether we are dealing with a period long enough to 
give the supplying industry time to expand or contract, 
or a shorter period. Over the long period Total Cost is the 
important influence in fixing the amount of supply, over 
the shorter period Prime Cost is the important influence. 
We must be quite clear also that the word supply means 



XIV VALUE 279 

a quantity at a price ; at different prices different amounts 
can be supplied by a producer or a trade without loss. It 
is theoretically possible to construct a supply schedule, 
giving the amount that can be supplied at each of a series of 
prices, or, what is the same thing, the prices at which each 
of a series of amounts can be supplied. Such a schedule 
would give us the prices or values towards which competition 
between sellers is constantly tending to drive commodities. 



Influence of Competition and Monopoly on Value 

A consideration of cost of production does not, however, 
exhaust the influences affecting value on the side of supply. 
There is an ambiguity in the word " supply." By the 
supply of a commodity may be meant either of two things : 
the amount that could be brought to market, or the amount 
that is brought to market ; the amount that could he 
offered for sale or the amount that is offered for sale. 
Now the " supply " which will fix, or help to fix, the value 
of the thing is the amount that is offered ; while 
the " supply " which is determined by the cost of production 
is the amount which could be offered. The two amounts 
do not necessarily coincide ; whether they do or do not, 
depends on the control of the product, or, in other words, 
on the extent to which competition between producers is 
operative. In considering, therefore, the influence of 
" supply " in fixing values, the conditions of control are as 
important as the conditions of production ; the conditions 
of production, as we have just seen, fix the cost of produc- 
tion, but the conditions of control fix the amount actually 
offered for sale. 

The two extreme conditions of control are complete 



280 ECONOMICS guap. 

monopoly and complete freedom of competition among 
sellers. The monopolist will work out the different costs 
of production for difierent amounts ; he will estimate the 
demand at different prices ; he will then put on the market 
that amount which will afford him the greatest difference 
between total costs and total receipts. If — as would 
probably be the case in an industry subject to decreasing 
cost — a small profit per unit on a large sale will give him 
a bigger total profit than a large profit per unit on a small 
sale, he will sell at the low price ; if — as would probably 
be the case in an industry subject to increasing cost — a 
large profit per unit on a small sale would give the biggest 
total profit, he will limit his output. The amount that is 
put on the market will probably not be the amount that 
could be put on the market, and the price or value of the 
commodity will bear no definite relation to its cost of 
production. The profits of monopoly consist of this margin 
between cost of production and sale price, which the 
monopolist is able to secure by his control of the supply. 

At the other extreme, under perfectly free competition, 
the amount that is offered will probably be the whole amount 
that could be offered, and the value of the thing will keep 
pretty close to its cost of production. There is no single 
agent controlling supply and able to restrict it, however 
much higher the price that could be obtained for a restricted 
supply. The producers, competing to sell, will none of 
them know exactly how much their competitors are putting 
on the market, and will hesitate to withhold a portion of 
their output, even if they think that the market is in danger 
of being glutted, for fear that their competitors will glut the 
market if they do not. They will none of them know what 
price their competitors will hold out for, and will therefore 
offer their product as near cost price as they can, for fear 



xi^r VALUE 281 

that their customer will take his custom elsewhere. We 
saw, when we were studying the meaning of competition, 
that the essence of it was the possession of an alternative 
and the exercise of choice by one party to the contract of 
sale ; monopoly is the abolition of the alternative and power 
of choice. 

Under free competition, then, the value of a thing will 
tend to coincide with its cost of production, and it has been 
usual to take this as the normal case. It would be just as 
reasonable to take monopoly as the normal case. Perfectly 
free competition is as rare as complete monopoly ; most 
actual cases in industry and commerce fall between the 
two extremes. One of the chief aims of business men is to 
introduce some element of monopoly into their business, 
to impose some restriction on competition. Competition 
presses on them like a head of water, forcing down the 
price of their product towards its cost of production ; any 
restriction they can impose on competition is a break-water, 
holding back the pressure and enabling them to maintain 
an additional margin of profit between market value and 
cost of production. Further consideration of this must be 
postponed to the chapter on Profits ; it is sufficient here 
to note that perfectly free competition among producers is 
the exception, not the rule, and wherever there is any 
restriction placed on competition among sellers, there is 
no surety that value will correspond with cost of production. 

There is one further obstacle to basing an explanation 
of values on the cost of production. The cost of production 
is itself reached by adding together a number of values ; 
it cannot determine value, since it is itself determined by 
value. The value of a manufactured article cannot be 
explained by its cost of production, because its cost of 
production depends on the values of the materials of which 



282 ECONOMICS chap 

it is made, the value of the machinery used to make it, 
and the value of the time and energy spent by different 
workers upon it. To say that value in general depends on 
the cost of production is to say merely that one value 
depends on other values, which depend again on other 
values, and so on in a circle. The circle, however, can be 
broken and the obstacle overcome — at the sacrifice of the 
simplicity and definiteness of the theory — by drawing 
a distinction between the expenses of production, which is 
what we have understood by cost of production hitherto, 
and the real cost of production, understanding by the real 
cost all the human efforts and sacrifices required to produce 
a commodity. The attraction of the Labour Theory lies in 
the fact that it bases value on the human effort required to 
give value to anything, and so explains value in terms of 
human life. 

The Cost of Production Theory, however, brings out 
another element in real cost. Labour without the aid of 
the saved up products of previous labour is comparatively 
unproductive ; this " saving up " of wealth to aid further 
production does not go on without some inducement, since 
most people prefer spending to saving. We may say, then, 
that saving involves a sacrifice of sorts, which is just as 
much a necessary element in the real cost of production 
as is the effort of labour. Senior called this sacrifice 
" abstinence " ; since the growth of great fortunes has made 
the term " abstinence " ridiculous. Dr. Marshall calls it 
" waiting." The sacrifice of the person who saves will 
seem negligible to the person who has to contribute to 
production the effort of labour, and quite rightly so ; 
still, under a system of private property, it has to be paid 
for, and the value of a thing must be big enough to induce 
the saving as well as the labour needed to produce it, or it 



XIV VALUE 283 

will not be fortlicoming. Hence in the real cost of produc- 
tion we must include all the efforts and sacrifices needed to 
produce a thing. 

This analysis of the meaning of " cost of production " 
and " supply " does not alter the fact that values cannot 
be explained by a consideration of the conditions of supply 
alone ; it should, however, help us to understand the 
influences on the side of supply which help to fix values. 
We have now to study demand. 



CHAPTER XV 

VALUE {continued) 

I 

Relation of Utility to Value 

In the previous chapter we saw that value cannot be 
explained from the side of supply alone. An analysis of 
the action of sellers showed that they invariably (so far 
as they are influenced by business motives) act on the 
railway company's principle of " charging what the trafl&c 
will bear/' of getting as good a price as they can from the 
buyer. How much then can the seller get ? He can get 
just what the consumer will give. How much at a given 
price can the producer sell ? He can sell just as much as 
the consumer will take at that price. The consumer has 
the deciding voice ; if he will not take the thing, he will not, 
and the producer, who has produced his things to sell, 
has them left on his hands. We have got to ask then what 
decides how much the consumer will pay, or how much he 
will take at a given price. 

The answer seems simple ; the consumer will pay just 
as much, having regard to his income, as he thinks the 
thing is worth to him ; nothing can make him pay more, 
and it is the seller's business to see that he does not pay 
less. The consumer buys things because they satisfy 

284 



OHAP. XV VALUE 285 

his wants ; he pays 10s. for a woollen shirt because he 
thinks that he cannot get more satisfaction^ a better 
10s.' worth, by buying anything else at the time. So 
the price which the producer can get for an article depends 
on the satisfaction which the seller thinks he can get from 
the article, in other words, on the utility of the article. The 
producer, in fixing the price at which he v/ill sell his product, 
or in fixing the amount which he will sell at a given price, is 
simply engaged in estimating (unconsciously of course) 
the utility of his product to the consuming public. He is 
not quite restricted to the task of estimating utility, he 
can do something to influence the consumer's opinion of 
utility ; we said that the consumer will pay just as much as 
he thinks the thing is worth to him, and a whole army of 
agents, advertisers and others are employed in this work 
of influencing consumers' opinions ; but ultimately things 
are bought because they satisfy wants ; however con- 
sumers' opinions may be influenced, consumers buy things 
because at the time they buy them they want them. 

It seems, then, that value depends on utility ; before 
we can accept this view as an explanation of value, we 
have two difficulties to overcome. The first is that the 
utility of a thing is different at different times and to 
different persons, while its value may remain the same. 
A loaf costs the same to the starving man, who spends his 
last threepence upon it, and to the dyspeptic millionaire, 
who could afford to give a thousand pounds for it, but will 
not be able to enjoy it when he gets it. The utility of a loaf 
is different to the two buyers, the price is the same. When 
we are hungry a loaf has a greater utility for us than when 
we are full ; we do not therefore pay a higher price for it. 
The reason for this uniformity of price or value is that the 
loaf is bought in a competitive market. If sellers could 



286 ECONOMICS chap. 

charge us according to our need, they would probably do 
so ; but there cannot be any great variations of price for 
the same article in the same market ; if the baker tried to 
charge us 4d. for a 3d. loaf just because we were hungry, 
we should go to another baker. Competition among sellers 
then generally ensures that an article shall have one price 
to all buyers in spite of the different utilities it has to 
different buyers. A monopolist could charge different 
prices to different customers ; wherever there is an agree- 
ment, explicit or tacit, among all the people in a trade or 
profession, different prices can be charged — doctors for 
instance make different charges for the same services accord- 
ing to the income and social position of their patients — 
but in most trades there is enough competition among 
sellers to ensure that the price of a commodity will not vary 
much in the same market. 

The other difficulty is greater ; so great is it that, as we 
have seen, the earlier economists decided that they must 
ignore utility in looking for the principle governing values 
and look exclusively to the side of supply. Utility and 
value seem to vary inversely with each other ; commodities 
such as bread, air, water, with the greatest utility — or, 
as Adam Smith called it, value in use — have often the 
lowest value in exchange, and conversely commodities 
with the highest value in exchange, such as diamonds, 
rare curiosities and pictures, seem to have little utility. 
The importance of the want satisfied by a commodity seems 
to have no influence on its value. The explanation of the 
difficulty lies in the fact that the utility of the total supply 
of a commodity is a very different thing from the utility of a 
given quantity of it, and it is the latter that we consider 
when we are comparing and measuring values. The entire 
supply of bread, water or air is obviously of infinitely 



XV VALUE 287 

greater utility than the entire supply of diamonds or pictures ; 
but entire supplies do not come into the market ; what 
the consumer considers in making purchases is a little 
more of this or a little more of that. It is not the utility 
of water to us that we measure in fixing our price for it;, 
but the utility of an extra tap in the garden or a lavatory 
on the ground floor ; it is not the utility of bread that we 
measure in deciding what price we can pay, but the satisfac- 
tion to be obtained from an extra loaf a week. And it is 
this " little more or less/' in Dr. Wicksteed's phrase, that 
we consider in comparing the desirability or utility of 
different commodities. In choosing our residence we 
hesitate between a little more fresh air, to be obtained by 
living in the country and paying railway fares to our work, 
and greater proximity to our work ; we hesitate between 
an addition to our collection of books and an addition to 
our furniture, between an extra ounce of tobacco a week 
and an additional subscription to the Workers' Educational 
Association. 

II 

The Marginal Utility Theory of Value 

It is always a little more or less, never the commodity 
as a whole, that we consider ; more food, more house-room, 
more clothes, more recreation and amusements ; the 
poorest of us have already some food, some shelter, some 
clothes, some recreation. And every addition to our 
supply of anything gives us a smaller satisfaction than the 
previous addition ; the more we have of a thing, the less 
we gain by adding to our store of it. If we already have 
three good meals a day, an additional meal will give us 
less satisfaction than the extra meal would give if we were 
increasing our meals from two to three ; if we live in a 



288 ECONOMICS chap. 

ten-roomed house and move into an eleven-roomed house^ 
the additional room gives less satisfaction than it would 
do if we were moving from a four-roomed house ; if we 
already have a summer suit, winter suit, dress suit and 
flannels, the opportunity of getting another suit will not 
appeal to us as it would do to a man with only one suit at 
present ; if we are members of ten clubs, possess three 
motors, a yacht and a country house, and can take a stall 
at the theatre whenever we want to, we shall not attach 
the same importance to a gallery ticket admitting to a 
cinematograph entertainment that a working lad does with 
only a shilling a week pocket-money. All wants tend to 
satiety ; if we have too much of a thing, we get, in the 
American's phrase, " fed up." There are apparent excep- 
tions ; alcohol stimulates the appetite which it feeds, 
but even alcohol, if administered continuously, will sooner 
or later make the drinker sick. It is sometimes said that 
the appetite for money is insatiable ; it is not ; the wants 
that money enables us to satisfy are so many and varied 
that we can find a use for money almost indefinitely, but 
for money itself, the coins, the appetite is not insatiable 
except in the case of that rare person the true miser, who 
is significantly called " abnormal." Wants differ very 
much in the rate at which they become satiated ; intellectual 
wants are usually satisfied much more slowly than physical 
wants ; but all wants tend to satiety. If it is asked why, 
we can only answer that it is a fundamental fact of our 
human nature. 

Let us apply this " law of diminishing utility " or 
" satiable wants " to the fixing of values. A pound of tea 
a week gives us a great satisfaction, we would willingly pay 
7s. for it rather than go without it ; a second pound of 
tea does not give us the same satisfaction, we would not 



XV VALUE 289 

give more than 4s. for it ; a third pound gives less 
satisfaction still, we would give 2s. for it but no more. 
But the pounds of tea are all alike, one in itself is as good 
as another, the difference in the amount of satisfaction 
they give is due to us. Further, there cannot be two 
prices for the same article in a competitive market ; all the 
pounds of tea of a given quality will have the same market 
value. Consequently the seller of the tea will not be able 
to charge us 7s. for the first pound, 4s. for the second, 
and 2s. for the third ; if he wishes to sell us two pounds he 
can charge only 4s. a pound, while if he wishes to sell us 
three pounds he will have to reduce his price to 2s. a pound. 
It is the utility of the pound of tea that we are just induced 
to purchase that settles the value of tea for us ; the total 
utility of tea has nothing to do with fixing its value, it is 
the utility of the little more or little less that we just find 
it worth while or not worth while to purchase that settles 
its value. To this " little more or little less " the term 
" marginal " has been applied, and its utility is the " mar- 
ginal utility " of tea. MarJcet values coincide with marginal 
utility.^ 

The importance of this theory lies in the explanation it 

1 It should be borne in mind that there are two " margins " in 
economic theory ; fh'st, the margin which is the result of competition, 
the margin meant in such phrases as " the margin of cultivation " 
and " the margin of production " ; and, second, the margin which ia 
the correlative of the principle of diminishing utility, the margin 
referred to when the phrase " marginal purchase " is used to describe 
the third pound of tea a week which satisfies a want just strong 
enough to induce us to purchase it at 2s. The first is a market margin, 
i.e. it is the result of differences among a large number of individual 
producers who are getting the same market price for their product ; 
the second is an individual or psychological margin, i.e. it is the result 
of the differences between the satisfactions given by successive 
pounds of the same tea. The two " margins " are often confused ; 
the marginal utility theory of value is concerned solely with the 
second. 



290 ECONOMICS chap. 

gives us of two otherwise inexplicable facts^ tlie fact that 
the things with the greatest importance to life have often 
the lowest market value^, and the fact^ recognised by every 
one and understood by so few^ that an increase in supply 
brings usually a fall in value. Important things like bread 
have a low value because most people have plenty^and sellers 
can only induce us to take all they produce by putting the 
price low. The total utility of bread is immense, but does 
not affect its value ; the utility of the loaves which a well- 
fed public are only just induced to buy is so low that the 
consumers will not pay more than 3d. the loaf. The world 
could get on very well without any diamonds at all ; yet 
the desire for display, which diamonds satisfy, is so far from 
being satisfied among the rich people who wear diamonds 
that they estimate at a very high value the satisfaction to 
be obtained from another diamond, and pay accordingly. 
Again, if the supply of anything is increased, the value will 
fall, because the additional supply satisfies a less intense 
want than the previous supply. Each person using or 
consuming the thing was already buying as much, at the 
old price, as the satisfaction it gave was worth to him ; 
every one will take an additional supply (which, in accord- 
ance with the principle of diminishing utility, will give less 
satisfaction) only at a lower price. For each individual 
the market-price is a thing given and fijsed, each decides 
how much he will buy at that price. But from the stand- 
point of the outside observer, the market-price itself is the 
result of all the individual valuations, since that price has 
been chosen by the sellers as being the price at which they 
could sell most at a profit. The price is fixed by the 
seller in the first instance, but in fixing the price he is un- 
consciously estimating the marginal utility of his commodity 
to the consumers. 



XV • VALUE 291 

A great part of the wealth of a modern community 
consists of machines and other aids to production which 
satisfy no want directly. Their value is derived from the 
value of the goods ready for consumption which they help 
to produce. If the demand for their products goes up, their 
value will rise with the value of their products ; if the supply 
of their products is increased, without any corresponding 
increase in the demand, their value will fall with the value 
of the products. Similarly the value of labour and of land 
are " derived " from the value of the goods they produce. 

The three historical theories of value reflect the condi- 
tions of industry at the times they were formulated. The 
Labour Theory explained values fairly well at a time when 
the division of labour was simple, and there was little power 
machinery and little trade ; manual labour was the only im- 
portant element in the cost of production, and in the narrow 
markets for which the labourer worked " allowance " was 
easily made for " hardship and ingenuity." When methods 
of production became more complicated, especially by the 
extensive use of power-machinery, it was felt that labour 
alone was not a sufficient explanation, and " Cost of Pro- 
duction " was substituted ; factories were still compara- 
tively simple and confined to a narrow range of products, 
the cost of which could be easily separated and computed. 
The typical modern firm includes many products in its 
output, the costs of which cannot always be analysed and 
computed separately ; hence " Cost of Production " is 
no longer an adequate explanation of values. No Cost of 
Production theory would ever explain why steak has a 
greater value than shin-beef from the same beast ; to-day 
the commodities which are supplied jointly, like steak and 
shin-beef, are innumerable, and any theory of value to be 
any use must account for their values. 



292 ECONOMICS chap. 

Ill 

The Law of Supply and Demaiid 

Our hasty survey of the chief historical theories of value 
has brought us back to our starting- place^ supply and 
demand ; it has not on that account been waste of time. We 
have learnt that there is no objective standard or measure 
of values except money ; any attempt to find an absolute 
standard in labour or cost of production leads to a circle in 
argument; for labour and all the other elements in cost of 
production themselves are valued and cannot therefore be 
used to value other things. We have also found that to 
ignore market values and try to find some " natural/' 
" permanent/' or '^ normal " value is rather a waste of 
time. Market values are the only values ever expressed 
as prices ; our only facts, therefore, are facts of market 
values, and market values are the only values that practi- 
cally afiect us. We have also learnt something about cost 
of production, and something about demand ; the Marginal 
Utility theory is only a more exact statement of the principle 
that value depends on supply and demand. We are now 
in a position to sum up our knowledge of supply and 
demand, and to realise the significance of the statement 
that value depends on supply and demand. 

It was said in the middle of the last century that you 
could make a good economist of a parrot by teaching it to 
repeat the words " supply and demand " ; a great many 
people have acted on this belief, and, having taught them- 
selves to repeat, like parrots, the words " supply and 
demand," have set up for economists. In spite of fi-equent 
misuse, however, the principle that value depends on supply 
and demand is extremely important ; a parrot that fully 



XV VALUE 293 

understood it would indeed be a good economist, but it seems 
to be beyond tlie comprehension of most parrots, human and 
otherwise. The principle does not mean that if we knew 
how much of a commodity was in existence and how much 
was wanted, we should be able to calculate its value ; desire 
for a thing has no influence on its value unless it is backed by 
the will and ability to purchase, and the supply of it has no 
influence on its value unless its owner is willing to sell. 

The supply of a thing, in the phrase " supply and de- 
mand," is the amount that will be offered for sale at each of 
a series of prices ; the demand is the amount that will be 
bought at each of a series of prices. The principle that value 
"olepends on supply and demand means that in the case of 
nearly every commodity, more will be bought if the price is 
lowered, less will be bought if the price is raised. Therefore 
sellers, if they wish to induce buyers to take more of a com- 
modity than they are already doing, must reduce its price ; 
if they raise its price, they will sell less. If there is a general 
falling oS in demand — due, say, to trade depression — 
sellers will either have to reduce prices or put less on the 
market ; they will not be able to sell the same amount 
at the same price. Similarly with supply. At a certain 
price a certain amount will be offered for sale, at a higher 
price more will be offered, at a lower price less. If consumers 
want more they must offer a higher price ; if they want less 
they will probably be able to force prices down. That is 
the first result of a change in demand or supply. 

The statement " value depends on supply and demand," 
however, does not express the whole truth ; it would be 
equally true to say " supply and demand depend on 
value." If there is a change in demand, sellers will in- 
crease or reduce supply to suit the demand, so that prices 
resume their old level ; if the sellers who control the supply 



294 ECONOMICS chap. 

anticipate exactly the changes beforehand, there will be no 
fluctuations in the value of the commodity at all. Similarly, 
if sellers reduce the supply and so send the value up, the 
increased value will check the demand and perhaps force 
the sellers to reduce prices again. Supply, demand and 
value depend on one another ; if one changes, the other 
two will be affected ; or a change in supply may be balanced 
by a change in demand, and value remain the same. 

In considering the supply of anything, we have to take 
into account the possibilities of the industry that produces 
it : if it is an industry in which an increased output means 
a decreased cost per unit, then the sellers may find them- 
selves able to meet a bigger demand at the lower price ; 
if, on the other hand, the commodity is one in which an 
increased output can be obtained only at an increased cost 
per unit, then the sellers may find it pays them to reduce 
the output and raise the price. In considering demand 
we must remember that, while it nearly always increases 
as price falls, the increase may be much or little in proportion 
to the fall in price ; in the case of common luxuries and 
commodities capable of many uses, the consumption may 
be stimulated greatly by a small reduction in price, the 
demand is, in technical phraseology, " elastic '' ; in the 
case of necessities, such as bread, of which most people 
have as much as they want, a large reduction in price may 
produce a very small increase in consumption, the demand 
is " inelastic." The elasticity of demand is also affected 
by the class of consumer to which the commodity appeals. 

The important influences then in determining the value of 
a thing are the nature of the supply of it — whether subject 
to increasing, decreasing or constant cost — and the elasticity 
of the demand for it. Further, if we wish to get behind 
the actions and reactions of the market, and to state the 



XV VALUE 295 

influences that fix value in terms of human life^ we shall 
still say that value depends on supply and demand ; but 
just as demand depends on the power of the commodity 
to satisfy human wants, so supply, in its turn, depends on 
the true cost of production, i.e. on all the human efforts 
and sacrifices needed to produce a thing — for nothing has 
value that can be obtained without effort or sacrifice. Value, 
in M. Pareto's phrase, " arises from the contrast between 
tastes and obstacles." 

This principle that value depends on supply and 
demand, or rather that value, supply and demand are 
interdependent, gives us the clue to the movements of the 
market. We have seen its fundamental importance in 
our study of commerce in Chapter III. and Chapter IV., and 
in our study of trade fluctuations in Chapter XIII. Value 
is the automatic indicator which production follows. If the 
want for a thing grows more intense, its demand rises, 
and therefore its value rises. The higher value induces 
producers to increase production, the supply is increased 
until it equals the demand, with the result that the value 
falls to its old level. Or suppose producers produce a thing 
in excess of the want for it, then its value will fall ; warned 
by the fall in value they will reduce the production of it, 
and with the reduction in supply, its value rises to the old 
level. A high value indicates that a thing is wanted much by 
the people who can pay for it, it also stimulates the supply 
of it ; a fall in value indicates that no more of a thing is 
wanted by the people who can pay for it, and at the same 
time discourages the further supply of it. Thus value comes 
to represent an equilibrium between production and wants, 
and one of the chief functions of the organisers of industry is 
to restore this equilibrium whenever it is disturbed. 

This interdependence of value, supply and demand 



296 ECONOMICS chap, xv 

is not inconsistent with the fixing of prices by monopolists 
or the State. If a monopolist fixes a price^ the demand 
adjusts itself to the price, and the monopolist will have to 
limit supply to the amount of that demand ; if he raises 
the price he will have to restrict his output ; if he wishes 
to increase his output, he will have to reduce the price in 
order to induce the public to take the increased supply. 
Similarly, if the State fixes the price, demand and supply 
adjust themselves to it ; when for example it fixes hackney 
cab fares at a shilling a mile, it restricts the supply of hackney 
cabs to those firms which can afford to ply them at a shilling 
a mile, and restricts the use of them to those people who can 
afford to pay a shilling a mile. If it raises its authorised 
price, it encourages supply and checks demand ; if it lowers 
the price, it stimulates demand and, for the moment at any 
rate, checks supply. A constant extension therefore of the 
State's regulating activity is possible, in the way of fixing 
prices and wages, without substituting for the present " law 
of supply and demand " any different operative principle 
for the direction of production. Such an extension is 
taking place, and the effect of it is to substitute formal 
and public correlation of supply and demand for the 
haphazard private methods of ordinary commerce. The 
interdependence of value, supply and demand would cease 
to be operative only if the State, substituting public for 
private initiative throughout the economic organisation, 
decided what should be produced, what work every one 
should do, how capital should be accumulated and applied, 
and land used, and how all goods and services produced 
should be distributed. 

Note. — The activities of the State during war, especially in 
Germany, show that the alternative indicated to the present system 
is not an impossible or inconceivable one. 



CHAPTER XVI 



WAGES 



Wages and Income 

A WORKMAN, asked what liis wages are, will probably answer 
with some such phrase as " thirty shillings a week." That 
is the return he gets for his labour, that is the value that 
society has put on his energy and skill ; the problem of 
wages for the economist is to discover how society came to 
put just that value on the workman's labour. Before, how- 
ever, we can examine the chief solutions that have been 
offered to this problem, we must understand what wages 
are, how much, in fact, we know about a man when he has 
told us that his wages are thirty shilhngs a week. 

Labour is paid for in many different ways, the two 
chief being by Time Wages and by Piece Wages. Presum- 
ably the employer endeavours to get the same amount of 
labour for his money whichever method he adopts. When 
the work is uniform and output can easily be measured, 
he usually prefers to pay the workman a fixed price per 
piece. In the textile industries the settlement of the price 
to be paid between workman and employer is often a difficult 
matter ; the calculation of wages from price-lists may be 
very complicated, the wage being the resultant of several 

297 



298 ECONOMICS chap. 

variables. If a basis for piece rates, however, can be reached, 
the employer is relieved of the task of " driving " his work- 
men ; since their wages depend on their output, they 
" drive " themselves. Some of the money saved in over- 
lookers' wages is usually spent in paying inspectors to 
examine the work and reject what is faulty. In many 
occupations, however, the work is so varied that there can 
be no standard by which the output of the worker can be 
measured, in others the quality of the work suffers when the 
worker is paid by the piece ; in such cases the employer will 
pay the worker by the amount of time he takes over the 
work, and pay overlookers to see that the worker does not 
waste his time. There are many variations and combina- 
tions of these two simple methods of paying for labour. 
In some occupations, again, payment for labour is made 
partly in kind, and the value of such receipts in kind must 
be reckoned in calculating the true wage : the agricultural 
labourer has often a cottage or garden at less than its full 
rent, the domestic servant receives board and lodging in 
addition to her money wage. In other occupations, such 
as the mason's and the grinder's, some deduction for trade 
expenses has to be made from the weekly wage before the 
true money wage is reached. 

The weekly wage, however calculated, is very far from 
giving the true economic position of the worker ; not the 
wage-rate but the income actually received determines his 
position. Hence the regularity or irregularity of work 
is a most important consideration in comparing the 
advantages of different occupations. Many casual workers 
are paid at a good rate while they are working, but their 
opportunities of work are so intermittent that their average 
weekly earnings are low and their economic condition 
correspondingly bad. The London Dockers in 1889, though 



XVI WAGES 299 

they secured the sixpence per hour for which they struck^ 
failed to make their occupation a tolerable one ; they did 
nothing to secure that each worker should have a suflScient 
number of hours of work each week to enable him to earn 
a sufl&cient number of sixpences to keep a family. Similarly 
in seasonal trades (including all trades affected by weather 
or fashion), the earnings of nine months may have to keep 
the worker during twelve months ; the weekly wages may 
be comparatively high, while the annual income is com- 
paratively low. The economic position of the worker in 
such a case can only be represented by the average obtained 
by adding together the earnings of the whole year^ bad 
weeks and good weeks together^ and dividing by fifty-two. 
The important thing is not what the trade pays the worker 
for an hour's work or a week's work^ but what it pays him 
for his services as a whole ; the worker and his family 
have to live for fifty-two weeks, even if the trade only uses 
his services for forty weeks. In the case of trades subject 
to considerable cyclical fluctuations, such as the ship- 
building trade, the average weekly wage has to be calculated 
over an even longer period. A worker may work overtime 
for eighteen months and then be on short time or without 
work for another eighteen months ; his true money wage 
is his average weekly earnings over the whole period. 

Perhaps we may go further and average a man's earnings 
not over a week or a year or three years, but over a life-time, 
and that not over the length of time he actually lives, but 
over the length of time a man ought to live if the conditions 
of his work are healthy. A trade employs a man, he adapts 
himself to its needs and thereby unfits himself for other 
work ; he is dependent on the trade for a livelihood, and 
his true rate of wages is the amount of his earnings divided 
by the number of weeks he has to live on them. This is not 



300 ECONOMICS chap. 

commonly recognised : a wage is called a " good wage " 
if tlie rate of payment per week is higli, though the employer 
may be exacting an amount of work from the worker so 
great that the man is " too old at forty." In the Heavy 
Steel trade of Pittsburg, that industrial paradise, wages are 
" high," but one man in three works twelve hours a day, 
seven days a week, and, once a fortnight, twenty-four hours 
on end ; in the corresponding occupations in England the 
wages earned are not more than half as much, but the working 
life is longer, so that the total earnings are probably not 
much less. Conditions of employment vary not only from 
trade to trade, but from firm to firm in the same trade ; 
an employer can frequently, by ofEering a wage slightly 
higher than his competitors pay, or by his efficiency or the 
efficiency of his subordinates as slave-drivers, induce his 
workmen to work themselves " out " by the age of forty. 
In such cases the true rate of wages should be calculated 
by adding up the worker's earnings and dividing the total, 
not by the twenty-five years he did work, but by the fifty 
years his working life ought to have lasted ; " high " 
wages when treated this way will often become low wages. 
Similarly, allowance must be made in the case of dangerous 
or unhealthy trades for periods of illness ; in the case, for 
example, of high school assistant mistresses, for the expense 
of an occasional nervous breakdown. 

The distinction between income and wage emerges in 
another connexion. The worker's wage is what he earns 
himself, the income on which his family can draw usually 
includes the earnings of some other member of the family. 
Although boys and girls do not usually hand over the whole 
of their earnings to their parents, they contribute something 
to the upkeep of the home ; and a man whose wife or children 
are earning might only make his economic position worse 



XVI WAGES 301 

by moving to a district, where he could command a higher 
wage himself, but his wife or children could find no employ- 
ment, or less remunerative employment. In spite of the 
tendency of modern industry to deal with the individual 
rather than with the family, the family is still an economic 
unit as well as a social unit for many purposes. 

So far we have been considering the money income of the 
worker ; the real income of the worker, however, consists 
of the goods and services that the money income will 
purchase, and the purchasing power of money varies from 
place to place, and from time to time. Allowance must 
be made for differences in the cost of living, a difficult and 
hazardous calculation to make, before we can compare 
wages in one country or district with wages in another, 
or wages at one time with wages at another. For instance, 
the high money wages of artisans in the United States are 
discounted by the high cost of living ; the rise in money 
wages in England since 1895 has been more than counter- 
balanced by the concurrent rise in prices. Whatever the 
cause of them, changes in the general level of prices do 
occur, wages usually do not rise as quickly or fall as quickly 
as prices, so that a great change in the economic condition 
of the wage-earning class may take place, of which the 
changes in money wages give no indication. 

So far we have been considering wages as an indication 
of the economic position of the worker. The weekly 
wage is only a rough indication of the true money income, 
and the money income may give a false impression of the 
real income. Other elements that can be subjected to no 
money measure enter into a comparison between different 
occupations ; social standing, opportunities of promotion, 
risk, independence, health, have all to be considered. 
" The attractiveness of a trade," in Dr. Marshall's words. 



302 ECONOMICS chap. 

" dependis not on its money earnings but on its Net 
Advantages." We have next to consider wages from the 
point of view of the employer. 

II 

Wages and Labour Cost 

How far do high wages mean high labour cost or value, 
how far are low wages " cheap labour " ? Labour cost and 
wages are constantly identified. Protection is defended on 
the ground that it keeps prices up, and high prices are 
needed to pay high wages. Labour leaders are told that 
higher wages will not benefit the workers because they 
will mean higher prices ; legislation to raise wages in 
" sweated " industries in England was opposed on the 
ground that " sweated " articles were bought chiefly by the 
very poor, and to raise the wages of the workers who made 
them would raise their prices and make it impossible for the 
poor to buy them. The fallacy in such arguments is easy 
to detect. The employer buys labour, not the labourer ; if 
he can get a great deal of labour from one man, it may pay 
him as well as, and will probably pay him better than, 
buying a little labour from each of two or three men. High 
wages, if the amount or quality of labour given in return 
for them corresponds, mean "cheap labour " ; low wages, if 
the labour given in return is inefficient or small in quantity, 
mean " dear labour." The cheapest textiles in the world 
are made in Lancashire, where textile " real " wages are the 
highest in the world. Dr. Schulze-Gaevernitz sums up the 
conclusions of his investigation into the relation between 
wages and product in the cotton industry in the sentence, 
" Where the cost of labour {i.e. piece wages) is lowest the 
conditions of labour are most favourable, the working day 



XVI WAGES 303 

is shortest and the weekly wage of the operative highest." 
Mr. and Mrs. Webb point out that some of the most 
expensive West of England fabrics are made by the lowest 
wage labour in the English woollen industry ; while some of 
the highest wages in the industry are earned by weavers of 
shoddy " tweeds " in the West Riding. 

Wages and the value of labour are two distinct things ; 
the value of labour, what it costs him, is the thing that 
matters to the employer, wages to the labourer. Wages may 
rise indefinitely without hurting the employer's interests, so 
long as his labour cost is not increased ; so long, that is, as 
he pays the higher wages only to workers who earn them by 
an equivalent output of labour, and can get as many workers 
of that quality as he needs. On the other hand an employer 
may by improved organisation reduce his labour cost {i.e. 
the value of labour) without disadvantage to the worker, 
if the result of the improved organisation is to enable the 
worker to earn more, though at lower piece-rates ; there 
is a limit, however, to this possible advantage in the danger 
of undue " speeding up " or " over-driving," The opposi- 
tion between employer's interest and worker's interest is 
wrongly conceived, if it is thought of as simply a difference 
about wages. It is to the employer's interest to beat down 
wages, only if the labour to be got from each worker is 
a fixed amount ; if an increase in wages will stimulate the 
worker to increased exertion and enable him to do better 
work, then it may pay the employer to raise wages, for by 
so doing he will be getting his labour as cheaply. Similarly, 
the worker can get the higher wages, which are his object, 
without increasing labour cost to his employer if he in- 
creases his efficiency ; it is of course to his interest that the 
value of labour should be as high as possible, but wages can 
be increased by increasing the amount of labour given 



304 ECONOMICS chap. 

for them without any change in the value or cost of labour. 
A Lancashire manager once came to manage a Yorkshire 
weaving establishment. Meeting an acquaintance soon 
afterwards he said : " I can't understand how you Yorkshire 
employers can get your labour for the wages you pay." 
After three months' experience of the " cheap " labour, he 
met the same acquaintance with a different tale : "I can't 
understand," he said, " how you Yorkshire manufacturers 
can pay the wages you do for the labour you get." 

Ill 

Wages and Trade Unionism 

Labour is not a commodity, but it is bought and sold 
like a commodity. Society (until recently) has allowed 
its price to be settled by the relations of supply and demand 
like the price of any commodity. Both the thing sold and 
the sellers of it, however, have characteristics which distin- 
guish labour from commodities. The seller of labour cannot 
control the quality of the supply. The labourer sells labour, 
he does not sell himself ; the quality of the labour he has 
to sell depends largely on his social environment, and 
especially on his parents. If he has been starved as a 
child in body and mind, his work as a man will suffer ; if 
no foresight was exercised in his choice of an occupation, 
and he was put to the trade which gave the biggest immediate 
wage and no prospects of anything better, he will have no 
special skill to sell. The expenditure of money and trouble 
on training is necessary in youth, if the labour of the man 
is to be valuable ; the investment must be made by the 
parents, the return comes not to the parents but to the 
child. Hence many parents do not make the investment 
even when they could. For the same reason the supply of 



XVI WAGES 305 

labour is adjusted to the demand only very slowly. The 
success with which it is done depends largely on the fore- 
sight of parents, and after all their pains some great technical 
invention may make their forecast wrong. Though he sells 
his labour and not himself the labourer must deliver it him- 
self. " It matters nothing to the seller of bricks whether 
they are to be used in building a palace or a sewer ; but 
it matters a great deal to the seller of labour " (Marshall). 
There may be a great demand for a certain kind of labour 
in one district, while in another district men with that kind 
of labour to sell are unemployed, yet unable to leave the 
district because they own their own houses or have children 
working. 

Again, labour, like time, will not keep : it must be sold 
at once or it is lost for ever ; it cannot be withheld from 
the market one day and saved till the demand is better. 
This characteristic of labour puts the seller of it in a weaker 
bargaining position than the buyer, and his position is 
usually the weaker without this aggravation. He has 
usually no reserve, or only a small reserve, and has therefore 
less power to wait ; he withholds his labour only at the 
risk of starvation or the Poor Law for himself and his 
family. He has usually an inferior knowledge of the 
market, of the prospects of trade and the demand even for 
his own labour ; is it likely that unaided he can match his 
wits against a keen business man and meet with success ? 
Again, he has only one unit of labour to sell, and is absolutely 
dependent on the sale of it ; the employer may be purchas- 
ing hundreds of xmits, and can easily dispense with any 
individual unit without loss. Their general carelessness 
about money-getting makes it a priori unlikely that working 
men get all they could in wages. Unlike their antagonists, 
the employers, they are not engaged in a struggle to get 

X 



306 ECONOMICS chap. 

rich ; like the scholar and the professional man, the ordinary 
working man is not interested in money-making. So long 
as he gets the wage to which he is accustomed, and gets it 
steadily, he is satisfied ; as a rule it is only when an attack 
is threatened on his customary standard, or rising prices 
invite an application for higher wages, that he fights with 
any energy. 

The trade union is an organisation designed to put the 
seller of labour on an equality with the buyer as regards 
bargaining strength. The first great weakness of the 
operative acting singly is his lack of any reserve that will 
enable him to hold out for a fair price for his labour. By 
associating with other operatives and forming a common 
fund, he can put a " reserve price " on his labour ; the 
union will maintain him while he is without work through 
refusing work at less than the standard rate. By contribut- 
ing to the common fund he " insures against " exploitation. 
The second great weakness of the operative acting singly is 
that he sells labour retail, while the employer buys it whole- 
sale. By associating with the other operatives in his trade, the 
seller is put on an equality with the buyer, or even given 
an advantage in this respect ; instead of having to deal 
with a single impecunious labourer, the employer has to 
bargain with a trade union secretary controlhng, if not all 
the labour in the trade, at any rate a sufficient proportion 
of it to inconvenience the employer who does not come to 
terms with him ; instead of risking the loss of a single 
labourer, the employer risks the loss of all or most of his 
labourers. And a trade union secretary or agent, appointed 
because an association for the purpose of collective bargain- 
ing must have officials, remedies the third great weakness of 
the operative, his ignorance of the market and lack of 
experience in salesmanship. Just as the business, man. 



XVI WAGES . 307 

however experienced liimself, employs the services of a 
specialised agent, the stock -broker, in selling his stock 
exchange securities ; just as the man of property who 
wishes to sell property, if he is wise, employs the assistance 
of a lawyer ; so the operative in an organised trade sells 
his labour through an agent, leaving the agent to settle the 
price. In London, where standards of social organisation 
are low, and in parts of America which seem to have no 
standards, employers object to their operatives using 
agents ; adopting the attitude of Pharaoh to Moses and 
Aaron, they insist on " dealing with the men direct." They 
assert a claim " to carry on their businesses in their own 
way," as if any business that controlled the fates of some 
hundreds of citizens and their families could be a purely 
private affair. In the industrial North, in the trades in 
which trade unionism is strong, employers as well as opera- 
tives have found it a convenience to deal through agents. 
The standard rate and standard conditions, the collective 
bargain, and the expert agent, are the chief aims of trade 
unionism ; friendly society work, strikes and even political 
work are only means to these ends. 



CHAPTER XVII 

WAGES (continued) 

I 

The Subsistence Theory of Wages 

Three theories have had a wide currency as explanations 
of wages. The earhest is the Subsistence Theory, the so- 
called " Iron Law of Wages," the theory that wages con- 
stantly tend to fall to the amount just necessary to maintain 
the labourer and bring up the new generation. It is a cost 
of production theory. It arose in the eighteenth century, 
when observation of labourers, especially in France, showed 
them in possession of a bare subsistence. Any increase 
in their incomes was followed, it was thought, by an increase 
in the population, and the competition of the additional 
labour would bring the remuneration of the labourer down 
to subsistence level again ; if, on the other hand, the labourer 
received less than subsistence, he would starve or his 
children would, and the consequent shortage of labourers 
would force the value of their labour up again to subsistence 
point. To-day the theorj'' is based on the behef that 
competition for work is so great that any subsidy to the 
labourer from the State or charity will merely induce him to 
accept a lower wage, leaving his income as it was. 

The theory is a gloomy doctrine and did much to earn 
for Political Economy the nickname of the " Dismal 

308 



CHAP. XVII 



WAGES 309 



Science " ; it is, however, a true account of the influences 
governing the remuneration of labour among unreflecting 
and custom-ridden people, who have never known more 
than a bare physical subsistence. The government of 
Egypt, since the EngUsh occupation, has doubled the 
wealth of Egypt, but the population has almost doubled 
also, and the individual fellaheen are therefore not very 
much better off ; the great irrigation works of India 
have made individual peasant-farmers somewhat richer, 
but their chief effect has been to increase their number. 
The Keport of the Royal Commission which recom- 
mended the reform of the English Poor Law in 1834 was 
based on this highly abstract theory and collected a large 
number of instances in which subsidies from the rates had 
depressed wages ; the Report, however, can hardly be 
taken as a reliable explanation of the condition of labour 
in 1834, since it ignored the enclosure of 7,000,000 acres 
of common, the destruction of the chief domestic industries, 
the rise of the early unregulated factories, the great war 
with its crushing burden of taxation, in a word, the Industrial 
Revolution ; and the evidence collected for the Royal 
Commission of 1905 suggests that subsidies from rates have 
little or no effect on wages to-day. 

The word " Subsistence " in this theory can be given no 
very definite meaning. Such attempts as those of Mr. 
Seebohm Rowntree to state an income which would just 
supply a family with the bare necessities for physical 
efficiency give the term a meaning, which is definite and 
valuable, but something quite different from the meaning 
it must bear in this theory of wages ; for it is only since 
the middle of the nineteenth century that a majority of 
the workers of any country have enjoyed a subsistence 
income according to his definition, and outside English- 



310 ECONOMICS chap. 

speaking countries it may be doubted whether a majority 
of the workers in any country have it to-day. Even if that 
difficulty be overcome, the history of the working classes 
in the nineteenth century has refuted the theory. In 
Western countries population does not respond to increases 
in wages in the way this theory requires. If anything, the 
reverse is the case ; as wages rise the birth-rate falls, and 
the lowest recorded birth-rates are in those states where 
the worker has exceptionally high wages, namely in Australia 
and among the native-born populations of Khode Island and 
New Jersey. In the United Kingdom, although population 
grew steadily, real wages trebled in the last seventy years 
of the nineteenth century. The theory, however, in a con- 
fused and unrecognised form, influences political thinking 
still, it accounts for a good deal of the opposition to social 
reform, and is still made the basis of Poor Law policy. 

II 

The Wages Fund Theory of Wages 

The Subsistence Theory was succeeded as the "orthodox" 
explanation of wages by the so-called Wages Fund Theory. 
The production of most commodities under modern con- 
ditions takes a long time ; the labourer has to Hve while 
he is waiting for the product of his labour ; what he Hves 
on while he is waiting is the accumulated stores of past 
production. In this sense wages are an advance from 
capital. Hence it was argued that " Wages depend mainly 
upon the demand and supply of labour ; or, as it is often ex- 
pressed, on the proportion between population and capital " 
(Mill). As a consequence of the theory it followed that, 
so long as the proportion between popvdation and capital 
remained unchanged, wages could rise in one industry only 



xvn WAGES 311 

at the expense of another. The proof of this rested on 
three assumptions : first, that wages could be increased 
only at the expense of profits (so long as the proportion 
of population to capital remained unchanged) ; second, 
that any fall in profits, due to such a rise in wages, would 
drive capital out of an industry or a country, and so lessen 
the demand for the labour ; third, that any rise in wages 
would attract new labour from other industries, which by 
its competition would force wages down again, or the rise 
in wages would lead to an increase in population, which 
would have the same eSect in forcing wages down. None 
of these assumptions are borne out by the facts. The first 
confuses wages with labour cost ; a rise in wages need 
diminish profits not at all, if accompanied by a correspond- 
ing rise in efficiency The second attributes to capital 
a sensitiveness which it does not in practice exhibit ; 
capitalists expect some fluctuations in profits, and the 
causes of fluctuations are so numerous that concessions to 
employees have not the overwhelming importance attached 
to them in this theory. The third assumption attributes 
to working men an adaptability, a knowledge of the labour 
market, and a determination to find the most remunerative 
employment, which they do not exhibit. 

The difficulty of squaring with the facts the broad 
statement that wages depend on the proportion between 
population and capital led Mill first to amplify and qualify 
it, and afterwards to abandon it. " By population," he 
said, " is here meant the number only of the labouring class, 
or rather of those who work for hire ; and by capital, only 
circulating capital, and not even the whole of that, but the 
part which is expended in the direct purchase of labour." 
The inconvenient fact of fluctuations in wages he could 
then explain by arguing that in times of depression some 



312 ECONOMICS ~ cha*. 

of the capital available for wages was withdrawn from use, 
and this inconvenient " capital which the owner does not 
employ in purchasing labour " "is the same thing to the 
labourers, for the time being, as if it did not exist " — for all 
the world like the wasted labour which Marx could not 
fit into his Labour Theory of Value, and which he said, 
therefore, " does not count." Only the capital actually 
spent on wages " counts " in this theory ; " nothing," 
Mill says, " can permanently alter general wages, except an 
increase or a diminution of capital itself (always meaning 
by the term, the funds of all sorts, destined for the payment 
of labour)," compared with the '^ quantity of labour offer- 
ing itself to be hired." Similarly nothing can permanently 
alter the general, which presumably means the average, 
price of turnips except an increase or a diminution of the 
funds of all sorts destined for the purchase of turnips, 
compared with the quantity of turnips offered for sale. All 
the theory amounts to in this exact form is that the amount 
received in wages depends on the amount spent in wages. 

The importance of the theory lies in its consequences, 
which, like those of the Subsistence Theory, still influence 
opinion, although the theory itself is dead. The exact 
statement of the theory has obviously no important conse- 
quences, but is easy to prove ; the loose statement, that 
wages depend on capital, cannot be proved, but has 
extremely important consequences. Now the proof of 
the unimportant exact statement gave authority to the 
important inferences to be drawn from the unproved 
general statement. If wages were fixed by the proportion 
between population and capital, trade unionism was futile 
and wicked ; it could raise the wages of one section of 
workers only at the expense of the wages of other sections ; 
wages generally coiild only be raised in two ways, by 



xvn WAGES 313 

increasing capital or checking population. This theory is 
the explanation therefore of the belief, common in the 
middle class, that PoHtical Economy has proved trade 
unionism to be futile. 



Ill 



Productivity Theories of Wages 

The weaknesses of the Wages Fund Theory directed 
attention to the influence which the efficiency or pro- 
ductivity of the worker exercises on wages, and recent 
theories base themselves on this influence. We have 
already had occasion to notice that high wages do not 
necessarily mean high labour cost. This fact lies at the 
basis of the productivity theory of wages. A worker 
who is efficient at his work will get high wages, because 
the product of his work will be great ; anything that 
increases the efficiency of the worker will, by making him 
more productive, tend to increase his wages. The chief 
contemporary explanation of wages is that competition 
secures for the labourer just what he produces ; " Wages," 
in Hadley's words, "... are the discounted product of 
industry," i.e. the value of the product less the interest on 
the wages from the time when they are paid to the time 
when the employer receives the price of the product. 

This conclusion is reached (or supported) by an analysis 
of the action of the employer who, as we saw, is the organiser 
of production. The different employers producing any 
commodity compete in the sale of it ; the price at which it 
is sold is a market price, settled by the general relations of 
the supply of the commodity and the demand for it, and 
therefore fixed or " given " for any individual employer. 
The endeavour to secure the productive economies of a 



314 ECONOMICS chap. 

large output leads employers to let their products go at 
any price that covers cost of production and leaves some 
profit, and an employer who fails to adopt the most suitable 
methods and appliances for keeping cost of production 
down is beaten out of the trade The price, then, which he 
gets for his product is fixed for the employer, not usually 
by him ; even if there are only a few employers or only one 
employer in the trade, the possibility of others entering 
the trade and the desire to sell a large output will keep 
prices down. Similarly competition between employers 
for land, labour and capital, will keep the prices of these 
agents of production up. For any individual employer 
the price he has to pay for any kind of labour is fixed by 
the power which the labourer has of taking his labour to 
some other employer, if his present employer will not give 
him the market price for it ; the price that any trade has 
to pay for its labour is fixed by the certainty that labour 
will be diverted from the trade, if other trades ofier better 
wages for the same degree of skill and exertion. Wages 
are usually the last thing that an employer, cutting down 
expenses, attacks ; partly because bargaining about wages, 
except in well-organised trades, may mean as many bargains 
as there are individual operatives, partly because discon- 
tented and hostile operatives give bad labour. Hence 
for the individual employer rates of wages, just like the 
rate of interest and the rent of land, may be taken as 
fixed. 

If, then, prices are fixed for him, and the rates he has to 
pay for his agents of production are fixed for him, what 
control can an employer exercise over his profits ? For 
his profits are merely the dift'erence between what he pays 
for the " agents of production " and what he receives for 
the product. There is one way in which he can increase 



xvn WAGES 315 

his profits under these conditions, namely by securing a 
more economical combination of the agents of production 
than his competitors. Papng the same rates of wages 
for labour, the same rate of interest for capital, the same 
rent for equally advantageous land as his competitors, 
he can still, by superior organisation, produce cheaper than 
they can, and, since he gets the same price as they, secure 
larger profits. He may employ his capital in more efiective 
forms, he may substitute machinery in a process usually 
performed by hand, he may plan his factory differently, 
he may combine the different grades of labour in different 
proportions, he may combine his materials differently or 
experiment with new materials ; even in the most elaborate 
and scientific industry there is always room for improve- 
ment and therefore for the ingenuity of the organiser. 

Hence employers are constantly comparing different 
kinds of labour, labour and capital, capital and land or its pro- 
ducts. They buy each simply according to its productivity. 
If by using more capital and less land or labour they can 
increase their product for a given expenditure, they will 
use more capital, and to get this additional capital will, 
if necessary, offer a higher price for it ; i.e. the rate of 
interest goes up because an addition to capital will increase 
production more than an addition to labour or land. If 
by employing more labour and, in proportion, less capital 
and land they can increase their product for a given ex- 
penditure, they will employ more labour, and to get it 
will, if necessary, offer higher wages ; i.e. wages go up 
because the productivity of labour has increased. In the 
same way the value of land is determined by its productivity 
to the user of it. Different kinds of labour are compared 
with each other in the same way, the employer using more 
overlookers or more general labourers or more machine- 



316 ECONOMICS chap. 

tenders, according as each will increase his production. 
Conversely, if labour is cheap, relatively to capital and 
land, the employer will use more of it ; if capital becomes 
cheap he will increase his use of capital ; if land is cheap 
he will use more land. Land, labour and capital compete 
through the employer for employment and payment ; he 
distributes his resources among them solely in proportion 
to their productivity ; i.e. their value depends on their 
productivity to the organisers of production. There is a 
struggle among the different possible agents of production 
for the survival of the JBittest, the " fittest " being the most 
productive ; the " selection " of the fittest is done by the 
employer in the act of organising production. Some writers 
speak of the employer in this connexion with the awe one 
would observe towards some stupendous natural force, and 
term this comparison of the agents of production the " Law 
of Substitution," 

The analysis is carried one step further : land, labour 
and capital are always employed together, no productive 
process can be carried on without the co-operation of all 
three. The question, therefore, before the employer is 
never, " Shall he employ any labour or miy capital or any 
land at all," but always, " Shall he employ more land and 
less labour and capital, or more labour and less land and 
capital, or more capital and less labour and. land ? " He 
considers the productivity not of land as a whole, labour 
as a whole, or capital as a whole, but of a little more or less 
of each ; hence economists (with that fondness for the 
word " marginal " which does so much to confuse the 
reader of a modern economic treatise) speak not of " Pro- 
ductivity " but of " Marginal Productivity," and say that 
the values of land, labour and capital ail depend on their 
" Marginal Productivity." 



xvn WAGES 317 

This refinement of the theory — like the Marginal Utility 
Theory of Value — is important because it brings out the 
relation of supply and demand in determining the value of 
an agent of production. When labour is plentiful, relatively 
to capital and land, as in Eastern countries, it will be 
employed in work which in richer countries is done by 
capital in the form of power-machines, and its work will 
be comparatively unproductive because it lacks tools, 
machines and other capital appliances ; therefore its wages 
will be low. In a new country, where land is plentiful and 
labour relatively scarce, labour will be employed only where 
its productivity is high, capital will be imported to supply 
it with the best implements and aids ; therefore wages will 
be high and rents low. The productivity of an agent of 
production depends on the amount of its supply relatively 
to the supply of the other agents with which it co-operates ; 
more of it, by lowering its productivity, will send its value 
down, less of it by raising its productivity will send its value 
up. Conversely a change in the organisation of production 
which increases its productivity will increase the demand 
for it and raise its value, a change that lowers its relative 
productivity will decrease the demand for it and send its 
value down. 

This theory seems to rely too much on the effectiveness 
of competition. It assumes too much in assuming, as it 
does, that employers will pay what they can pay. They 
can pay the worker the value of what the worker contributes 
to production ; they need not do so unless the competition 
among employers for labour is at least as strong as the 
competition among workers for employment. Now 
although there are usually employers wanting labour as 
well as workers wanting employment, there are usually 
more workers wanting employment than workers wanted 



318 ECONOMICS chap. 

by employers. The exponents of the theory argue that the 
competition among employers must be the keener for three 
reasons : they have buildings and plant which earn them 
nothing if they cannot get labour ; they have a " connexion " 
in their market which they run the risk of losing by any 
stoppage ; and they are always anxious to increase their 
output in order to avail themselves of the decreased cost 
of production which is usually possible with a larger output ; 
to these may be added the even more important considera- 
tion that the employer can make profits by successful 
anticipation of the needs of the consumer as well as by 
capable organising work, without paying the labourer any 
less than the discounted value of his product. Against 
these considerations must be set the fact that the labourer 
risks more than the employer if they cannot come to terms ; 
the employer risks loss of profits, the labourer risks starva- 
tion and the starvation of his wife and children, or alterna- 
tively, the degradation of the Poor Law ; if the employer 
risks having his plant standing idle, the labourer risks 
having to break up his home, leave the town he is attached 
to, and seek employment in a new district. On both sides 
the risk of loss is so great that the parties usually come to 
terms with surprisingly few disputes ; and the connexion 
between any individual employer and any individual 
workman is in most trades one which can be broken only 
with loss to both, since a workman who has been some time 
in a shop is worth more to his employer than a new man 
would be or than he would be in another shop. 

Although the employer can make profits while giving 
full productivity value for labour, it is a characteristic of 
business that a man takes what he can get, and an employer 
would be merely unbusiness-like who did not take advantage 
of the labourer's weakness as a bargainer ; fortunately 



xvn WAGES 319 

some business men are unbusiness-like. Moreover the 
" productivity " of the labourer depends, more than on any- 
thing else, on the employer's powers of organisation. Slack 
organisation on the part of the employers in a district will 
make the labour of the district less productive than labour 
of the same skill and the same intensity in districts where 
employers do their organising work better. To say in 
such a case that wages are low because the productivity 
of labour is low may be true, but it is to suggest that the 
workman is to blame when really the employer is at fault. 
Where this is the case, the workers, by insisting on higher 
wages, may increase their productivity without in the least 
increasing their labours ; for the productivity of a given 
amount of labour will be increased when the employer 
abolishes waste, removes disorganisation, and supplies 
his workers with the best appliances. 

The word productivity requires examination. The 
word usually means " output " measured by the yard, 
ton, or bushel. But when we say that wages depend on the 
productivity of labour, productivity is not equivalent to 
" output " ; it means merely " productivity of market- 
value," which may correspond with output, but also may 
not. If a king dies suddenly, there is a sudden increase in 
the value of mourning goods ; the labour, of which these 
goods are a product, has become more " productive/' 
although the skill and exertions of the labourer, and the 
number of yards of cloth he turns out, are precisely the same 
as they were before. This distinction is often forgotten, 
and the productivity theory of distribution comes to be 
used (unconsciously perhaps) as a justification of the present 
unequal distribution of the national income. Each, it 
seems to show, gets what he produces ; what could be 
fairer ? It is forgotten that the market-value by which 



320 ECONOMICS chap. 

this productivity is measured bears no constant relation 
to social service. The theory is true (if at all) only if we 
give " productivity " its second meaning, " productivity 
of value," the theory justifies the present distribution, 
(if at all) only if it has its first meaning, " output." In 
the only sense of the word " productivity " in which the 
productivity theory of distribution is true, the man who 
receives £3 a week for looking after Pekinese puppies for 
an American countess is four times as " productive " as the 
Oxfordshire farm-labourer receiving 15s. a week ; the 
services of the two to society do not bear the same relation. 
To avoid the ambiguity of the word " productivity," 
the commoner word " efficiency " is sometimes substituted, 
and wages are said to depend on efficiency. But the new 
word is not free from ambiguity itself ; efficiency will help 
to explain differences in wages in the same occupation, since 
such differences will be reflected in output, but it will not 
explain differences in wages in dijferent occupations. We 
have no common measure of efficiency in different occupa- 
tions except the wages paid, so that to use efficiency to 
explain the wages is to beg the question. The low- wage 
worker may be just as efficient at his work as the high- wage 
worker at his, and the low-wage work may be equally in- 
dispensable to society ; while it may be true that the low- 
wage worker could not do the high-wage worker's work, it 
may be equally true that the high-wage worker could not 
do the low-wage work ; a joiner could not (without a fresh 
industrial training) tend a spinning mule, but neither could 
a spinner (without a fresh industrial training) frame a roof. 
Yet another principle of wages has been offered in "Economic 
Worth.'' ^ Economic Worth, however, turns out on ex- 
amination to be merely a misleading synonym for pro- 
^ Smart, Distribution of Income, p. 322. 



xvn WAGES 321 

ductivity of market value — misleading because the plain 
man always associates witli the word " worth " the idea of 
moral desert, so that the statement that distribution is in 
accordance with " economic worth " inevitably carries with 
it the suggestion that the poor are poor because they are 
bad and the rich are rich because they are good. 

IV 

The Influence on Wages of the Standard of Life 

The theories which we have been considering are really 
attempts to answer different questions about wages. The 
different theories are not necessarily inconsistent ; each 
may contain and express one important influence on wages, 
while neglecting other influences. There are three problems 
of practical importance involved in the apparently simple 
question, What fijses wages ? 

(1) What fixes the share that goes to labour of the joint 
product of labour, land, and capital ? 

(2) How is it that wages in England are usually higher 
than wages on the Continent, and usually lower than in the 
English-speaking communities overseas ? 

(3) Why do wages vary in diflerent occupations ? and 
what fixes the relation between wages in diflerent occupa- 
tions ? 

The Subsistence Theory, while professing to beacomplete 
explanation of wages, was directed primarily to answering 
the first question ; for the first question was the question of 
most interest in an age when labourers were everywhere 
poor, although most things were made by manual labour 
with little aid from capital. It found the explanation of 
low wages in the competition of the labourers for employ- 
ment, which kept wages down to a bare subsistence. The 

Y 



322 ECONOMICS csa^. 

theory einpliasises the importance of the influence — com- 
petition for employment — which makes labour, although it 
is indispensable, be content with only a share, and not a 
very large share, of the joint product. The theory, however, 
fails to give a satisfactory explanation of wages, because it 
assumes unlimited competition among labourers for employ- 
ment. So far as limits are placed on competition among 
labourers, wages can be kept above bare subsistence level. 
Now hmits are placed on competition. The object of trade 
unionism is to place a limit on competition for employment ; 
a trade union is an association of workers with a particular 
kind of labour to dispose of who agree not to accept wages 
below a certain rate, and if necessary to prefer unemploy- 
ment. But apart from the overt action of trade unions, 
competition is very seldom without limits ; there is in 
nearly all occupations a tacit and informal agreement 
among the workers to observe a certain standard of life and 
to refuse any wage which will not support that standard. 
If we substitute " standard of life " for " subsistence " 
in the theory, it will throw a great deal of hght on wages. 
The Subsistence Theory made the mistake that Mill made 
of identifying the " supply of labour " with the population; 
the two are distinct, because the population consists of 
human beings with wills of their own, who can vary the 
amount of labour they can and wiU give. Unless the wage 
offered will cover the standard of life of the worker, he 
will usually refuse to supply any labour at all, confident 
that no one else who can do the work wiU take it at a less 
rate than himself. Wages then cannot usually fall below 
the standard ; they will not rise much above it, partly 
because competition among employers will deter them 
from offering more, partly because the ordinary workman, 
once he has got his standard of life secured, has little 



svn WAGES 323 

further interest in money-getting and will not press for 
more. 

In considering the meaning of the word Supply in Chapter 
XIV. we found it necessary to distinguish between two uses 
of the word : (1) the amount of a commodity that exists, 
or can be produced within a given time ; (2) the amount 
of the commodity that is or will be offered for sale. Whether 
the two amounts coincide or not depends, we saw, on the 
control of the commodity. Where free competition in 
selHng obtains, they will coincide ; where there is some 
restriction on competition, they need not coincide. In 
the same way the " supply of labour " m.ay mean either 
of two things : (1) the entire energies of the entire popula- 
tion ; (2) the amount of work that the population is induced 
to perform. It is the supply of labour in the second sense 
that influences wages, just as it is the " supply " of a 
commodity in the second sense of that word that influences 
value. And in the case of labour the existence of tacit 
or explicit agreement to restrict competition in seUing 
makes it unlikely that the " supply of labour " in the second 
sense will ever be exactly the same thing as the " supply 
of labour " in the first sense. 

The Standard of Life is a conception that is seldom 
defined, yet is not indefinite ; it is difficult to express in 
pounds, shillings, and pence, yet it is held with sufficient 
clearness to influence action. The conception becomes 
more comprehensible if we speak of standards rather than 
the standard, because a workman's conception of the wage 
to which he thinks himself entitled is influenced by several 
standards. There is the " grade " standard ; the man 
with a trade considers that he is entitled to a living about 
50 per cent better than that of his labourer. There is the 
trade standard ; the relation of spinners' to weavers' wages 



324 ECONOMICS chap. 

in any given district and branch of the textile trades is well 
understood, and a change in one would probably lead to a 
demand for a change in the other. There is the district 
standard ; the Lancashire textile operative expects and gets 
a higher wage than the Yorkshire textile operative, the 
Huddersfield than the Leeds weaver ; and, similarly, 
countries have different standards, after all due allowance 
has been made for differences in the cost of living. There 
are many standards, and the principles on which they vary 
are many ; but the conception of a standard of life is definite 
enough and influential everywhere.-*- 

1 The head of an English firm of milling -machinery makers 
recently discovered that there were among the firm's employees a 
number of labourers receiving a wage of only 18s. a week. The 
settlement of wages being a department of the firm's business he 
delegated to a subordinate, he had been ignorant of this, and at 
once had the wages raised to a guinea a week. (Apparently he was 
ignorant of the " law " that competition forces the entrepreneur 
to hand over to the labourer the exact equivalent of his productivity.) 
The immediate result was that a class of machinists, whom he con- 
sidered quite well paid at the wage they were receiving, about 27s. a 
week, demanded a corresponding advance. The relation of the two 
standards was so clear to them, that they conceived that they had a 
right to the advance. Labourers with a recognised industrial status 
usually receive about two -thirds the wage of the tradesmen with 
whom they work. The influence of the conception is illustrated by 
the comparative uniformity of earnings where wages are on a piece- 
rate basis. Variations occur, but they are not sufficient to destroy 
the conception of a standard ; rather, the workers adjust their pro- 
ductivity to the standard. For the same reason, as has often been 
noticed, piece-workers' hours of work can be reduced gradually 
without any reduction of output ; the workers aim at a standard 
wage, and do enough work, whatever the time at their disposal, to 
earn it. If there were no such standard, such a question as " What 
wage does a Bolton spinner earn ? " would be meaningless ; we 
could only ask " What rate is he paid at ? " In occupations where a 
standard time wage is paid, there are differences of efficiency and 
industry among workers receiving the same wage ; employers, how- 
ever, tolerate them, because the more efficient compensate for the 
less efficient, and an exact adjustment of wages to output would 
usually not repay them for the trouble involved, while the operatives 



xvii WAGES 325 

Certain modern methods of remuneration, economical 
to the employer but justly suspect with the operative, are 
based on the influence of this conception of a standard. 
The premium bonus system is the type of them. A piece 
of work will be timed ; since the worker cannot be expected 
to work at full strain all the day, a proportion, usually a 
third, will be added to this time, and the resulting time is 
taken as the standard time in which the piece of work ought 
to be done. Then the worker is encouraged to get more use 
out of his employer's plant by being promised a reward if 
he does the piece of work in less than the standard time. 
He is not given, however, the full saving effected by his 
diligence ; the employer does not find it necessary to give 
him the full equivalent of his additional output ; it is usually 
divided equally between employer and operative. If the 
operative saves an hour on the standard time, he will be 
given an additional half-liour's pay ; if, for example, he 
gets four hours' work (according to the agreed standard) 
done in three hours' actual time, he is paid for three and a 
half, not for four hour's work ; i.e. the employer gets the 
extra hour's workout of him for an extra half-hour's payment, 
in addition to extra earnings by his plant due to the greater 
use of it. Why is this possible ? How is it that workers 
who would strike against a reduction of 6d. a week on their 
standard wage will cheerfully give 10 per cent more work for 
5 per cent more payment ? The reason would seem to be 
that their demand is governed by their conception of a 
standard wage. Regarding, say, 36s. a week as their due, 
because 36s. is the standard of the trade, grade and district, 

tolerate them because they are dominated by this conception of the 
standard, to which the less efficient as well as the more efficient are 
entitled. The manual workers as a class believe that if a man will 
not work neither shall he eat ; but they have never subscribed to 
the economic doctrine that a man should eat in proportion to his work. 



326 ECONOMICS chap. 

they will fight strenuously for 36s., and will usually prefer 
unemployment to accepting a lower wage ; but once they 
have got their standard, anything above that is so much " in 
their pocket," and they will not higgle about the price of the 
extra labour. Employers, recognising this, usually induce 
men to accept the premium bonus system by guaranteeing 
the standard wage or something above the trade union 
standard. It should be noticed that encroachment on the 
workman's leisure is a different thing ; if the employer asks 
him to exceed his standard time, the employer has to pay 
time and a quarter or time and a half for the excess ; but 
apparently he can induce the worker to exceed his standard 
output by paying him half-time rates for the excess. 

To the influence of the same conception of a standard may 
be put down the carelessness about spending any excess of 
the standard wage, which has been more frequently noticed 
than the corresponding carelessness about money-getting 
in excess of the standard. We are told that labourers 
accustomed to £1 a week, if their wages are raised, will 
spend the additional income in riotous living. Certainly 
any windfall, whether it take the form of a legacy, a com- 
pensation payment or a sudden increase in wages, is spent 
with less economy than the standard wage ; the expenditure 
of the workman's standard wage is probably — in spite of 
middle-class critics who have never tried to live on £1 a 
week — the most economical spending done in the community, 
but anything above the normal will be spent with less care, 
just as in the middle class sudden wealth usually leads to 
extravagance. Cases do occur where the influence of this 
conception takes another form, and the labourer prefers to 
work less at the new rate, so that his actual income remains 
unchanged ; this will only happen when the standard of 
life is very low, as it is, for example, among casual dock 



xxn WAGES 327 

labourers. There are occupations in which no standard 
does exist, the so-called " sweated trades " ; in them the 
workers' spirits have been broken ; they are incapable of the 
tacit combination needed to maintain a standard, and they 
can ofier no resistance to any encroachment on their Hveli- 
hood. The Subsistence Theory is a true explanation of 
their wages ; and since they are unable to set up and protect 
a standard for themselves, it is essential, to prevent social 
degeneration, that the State step in and impose a standard 
from outside. 

In most cases, however, a standard exists ; it is not a 
permanently fixed thing, but relatively to other economic 
influences it is fixed, and it imposes an effective restriction 
on competition. The trade union, when it exists, is 
primarily an organisation for protecting this standard, 
and, as opportunity occurs, forcing it up. The other 
two theories of wages ignore this important fact of social 
psychology, although they may be not inconsistent with 
it. They assume that the worker will always insist on 
getting the absolute maximum that he can get, i.e. that he 
is actuated in his economic relations by purely commercial 
motives. He is not ; although commercialism is invading 
his moral ideas, percolating downwards from the commercial 
class, his principle is much nearer to that which Ruskin 
preached, " Unto this last even as unto thee." 

This conception of the standard of life, though fluctuat- 
ing, is a relatively fixed thing in the flux of forces which 
determine distribution. The workman by combination, 
tacit or explicit, fixes it, and his employer adjusts production 
to it. The employer will do all in his power, usually with 
success, to secure an increase in output in return for every 
increase in wages, and, where the local standard compels 
him to pay higher wages than his competitors in other 



328 ECONOMICS chap. 

districts, to extract an amount of work correspondingly 
greater. Hence the theory that wages are fixed by the 
worker's standard of life is not inconsistent with the theory 
that wages correspond with the worker's efficiency ; the 
worker fixes the standard, and the employer sees to it that 
his efficiency correspoiids. It is not suggested, of course, 
that the worker can raise his wages by the simple process 
of spending more ; the conception of the standard of life 
influences wages only by producing concerted action or tacit 
combination among the workers who supply a certain kind 
of labour. For this reason it is usually more influential in 
stiffening their backs against a reduction in wages than in 
accelerating an advance. Anything that leads the workers 
to act together increases their control over wages ; this 
conception of the standard of life leads them to act together, 
almost automatically, whenever real wages are threatened. 
It corresponds in industrial warfare to the trenches v/ith 
which a modern army secures its line ; it is a defence against 
attack, and a means by which any new advance may be 
made secure. 



The Influence on Wages of the Volume of the National 
Dividend 

The Wages Fund Theory was directed primarily to 
answering the second question, how is it that wages are 
usually higher in England than on the Continent. It calls 
attention to the very important fact, that quite apart from 
the distribution of a country's wealth between land, labour 
and capital, the amounts which all three receive are in- 
fluenced by the amount of that wealth. If we can assume 
that the distribution between the three factors proceeds 
on much the same principles in difierent countries, then the 



xvn WAGES 329 

different levels of wages in different countries must be due 
to differences in the amount of the fund or flow of wealth 
to be distributed. 

The supporters of the Wages Fund Theory made the 
mistake (natural enough at the time) of assuming that 
capital was the only important influence on that fund or 
flow. A wider observation of facts has shown that the 
amount of a country's wealth — the " National Dividend," 
as Dr. Marshall calls it — depends not solely on the amount 
of capital employed, but also on the quality of the labour 
and the nature and amount of the natural resources of 
the country. Workers enjoying a high standard of life 
and well trained industrially increase the National Dividend 
as much as an increase in capital will increase it, and 
may increase wages without trenching on the profits of 
capital ; similarly wages can be high without trenching on 
profits, where a few million people have at their disposal 
the resources of a continent, as they have in Australia. If 
the natural resources of a country, or its accumulated 
capital, or the science and skill of its inhabitants are great 
relatively to the number of its inhabitants, wages will be 
high ; if population is dense, and there is little accumulation 
of capital (as in India), or there are no exceptional natural 
resources (as in Belgium) to swell the National Dividend, 
wages will be low. Mill was quite right in arguing that 
any action of the worker that checked the accumulation 
of capital would tend to check the growth of wages, since 
it would check the National Dividend, on which wages as 
well as profits and rent depend ; he was wrong in assuming 
that a rise in wages 7nust check the accumulation of capital, 
and that the accumulation of capital was the only important 
method of increasing the National Dividend. 



330 ECONOMICS chap. 

VI 

The Influence on Wages of Inequality of Opportunity 

The Marginal Productivity Theory seeks to answer all 
three questions at once. The first question it answers 
adequately by saying that the share of the National Dividend 
going to labour depends on the productivity of labour 
relative to the productivity of capital and natural resources, 
and this depends on its relative plenty or scarcity. The 
second problem it solves by referring to the different levels 
of productivity in different countries or districts, which 
correspond with the different wage levels. English cotton 
operatives have high wages compared with the cotton 
operatives of the East, because they produce cotton goods 
of more value in a given time ; agricultural labourers in 
the North of England earn higher wages than agricultural 
labourers in the South, because they do more work or better 
work. These two questions it answers ; it is not much 
help with the third problem, the problem why different 
kinds of labour have different values. Its explanation 
is that wages depend on the relation between the demand 
for a kind of labour and the number of people who can offer 
it. Each worker's wages depend on the " productivity " 
of his labour, and the " productivity " of that labour 
compared with other kinds of labour depends on the number 
of people offering that kind of labour. This explanation, 
however, only states the problem, it does not solve it. The 
important question is, how is it that, relatively to the 
demand in each case, a large number of people can offer 
certain kinds of labour, while only a smaU number can offer 
other kinds. The question is the same as the question, why 
different standards of life exist together. What is the 



xvii WAGES 331 

explanation of the fact that lawyers are few, so that their 
marginal productivity and therefore their earnings are high, 
while ploughmen are numerous, so that their marginal 
productivity and therefore their wages are low ? The 
ploughmen could not do the lawyer's work, it is true, but 
neither could the lawyers plough. Similarly in the case of 
manual occupations : why are dockers many and spinners 
few ? 

The answer cannot be reached by any analysis of 
existing conditions ; a full explanation could only be found 
by an exhaustive historical enquiry into the occupations 
under comparison. Analysis will serve merely to indicate 
some important influences. The difiiculty of the work is 
the explanation in some cases ; if a high degree of intelligence 
is required to do the work at all, the number of people who 
can do it will be limited. This explanation will not carry 
us very far. All the operations needed to supply all the 
ordinary needs of Hfe have been studied and simplified, 
until any person of ordinary intelligence, provided he have 
had the necessary training, can do most of them. Incomes 
derived from work vary far more than do native ability 
and capacity. The opportunity of training and entry 
into trades is then the important influence and the funda- 
mental* reason for the difference in the wages of different 
occupations. Low-paid occupations are low-paid because 
they are overcrowded, while a high remuneration is secured 
for an occupation by restricting entrance to it. 

The restrictions take many forms. In the case of the 
learned professions the restriction takes the form of an expen- 
sive education ; by their monopoly of higher education the 
middle and upper classes retain a monopoly of the professions 
— with the scholarship system as a fairly efficient safety- 
valve for the discontent of the excluded masses. This 



332 ECONOMICS chap. 

monopoly is further buttressed by tlie fees required on 
entrance to such professions as the law, which handicap 
clerks and others who might secure the necessary education. 
Similarly, the higher branches of the public service are re- 
served for the same classes by the nature of the examination 
where appointment is by examination, by " influence " and 
class prejudice where appointment is direct. Even in in- 
dustry and commerce class prejudice closes the road to the 
more important posts to all save exceptional working men. 
Large employers favour subordinates of their own social 
class, so that the working man gets few chances of training 
himself for posts of direction ; the middle-class boy on 
entering a trade is given an all-round training, the working- 
class boy is specialised to one sub-section by the age of 
sixteen. In the case of manual work, the need of special 
skill for the better-paid occupations excludes from them 
the many people who have the capacity but have never 
had the opportunity to acquire that skill. In some cases the 
apprenticeship system, in a few trade union organisation, 
restrict opportunity to enter a trade, in the same way as 
educational requirements limit entrance to the professions ; 
but here again the important influence is the expense of 
training. With equality of opportunity work and earnings 
might tend to correspond with native capacity ; as it is, 
the distribution among occupations of the nation's capacity 
is almost purely accidental. 



VII 

Summary 

If now we return to the question which formed our 
starting-point — how society came to put a value of just 



xvn WAGES 333 

30s. on the work of a certain workman — we shall be imable 
to answer it by reference to any single principle. 

We shall note fii'st that a clear distinction must be drawn 
between wages and the value of labour, or, as it is more 
usually called, labour cost. Other things being equal, the 
more labour a man's energy, ability, training and social cir- 
cumstances enable him to give, the higher the wage he will 
be able to command ; the less labour he gives, the lower his 
wages win tend to be. Hence there may be great variation 
in the wages of similar workers from place to place and from 
time to time without any variation in the value of labour, 
and consequently without any change in cost of production 
to employers and in prices to consumer. 

But the value of labour also varies from place to place, 
from time to time, and from occupation to occupation ; this 
variation is independent of differences in the amount of 
labour given by different workers, and it needs explanation. 
Any theory, however, that attempted to comprehend all the 
influences on the value of labour in a single formula would 
be so abstract as to be useless. Moreover, some wages are 
capable of no rational explanation ; the House of Commons 
Committee on Sweating (1906) found cases in which different 
rates of wages were being paid for exactly the same work, 
and similar variations are to be foimd in all unorganised 
trades. All we can do — all any theory of wages can do — 
is to enumerate influences and indicate their relation and 
importance. Our survey of past theories suggests that 
there are three important influences in the long run : the 
volume of the flow of wealth in the country of the worker ; 
the relative plenty or scarcity of the different agents of 
production ; the relative plenty or scarcity of different 
kinds of labour. While these are the chief determining 
influences in the long run, the chief immediate influence 



334 ECONOMICS chaf. xvii 

is tlie worker's conception of the standard of life to whicli 
he is entitled — by tacit agreement with his fellow-workers 
he will usually refuse to work at all for a wage insufficient 
to maintain this standard, and the consumers will be 
forced to pay his employer a price for the product of 
the work sufficient to enable the employer to pay him 
that wage. 



CHAPTEE XVIII 



INTEREST AND PROFITS 



The Distinction between Profits and Interest 

The words Interest and Profits are often used indifierently 
for the same thing ; if we wish to avoid confusion we must 
distinguish between them. Profits are the share in the 
flow of wealth which goes to the owners of businesses, and 
are calculated by deducting the expenses from the receipts 
of businesses ; interest is the share that goes to the 
owners of capital. Profits usually include interest, since 
the owners of businesses usually supply some, if not all, the 
capital us^d in them ; they include, however, several other 
important elements. 

First, profits usually include some payment for the 
work of organisation, which we studied in Chapter III. 
The owner of a private business works, he gets his wages 
in the form of profits. He gathers together a number 
of specialised workers, provides them with the necessary 
machines and equipment, finds material to work on, 
and turns these isolated individuals and machines into 
a productive organisation. The business started has to be 
run, the organisation has to be managed just as a machine 
has to be tended, and the owner-manager has to be paid by 

335 



336 ECONOMICS chap. 

society like any other machine -tender. In a majority of 
cases he draws his payment for management in the form 
of profits. As we saw, starting a business needs a different 
and a higher order of abihty than running one, and the 
biggest profits are probably made by the starting of busi- 
nesses, by discovering a new or unsatisfied want and organ- 
ising the means of satisfying it. The payment for this 
work may be drawn, not in annual payments, but in a 
lump sum, the creator of the business selling it to the public 
in the form of a joint-stock company, and receiving for it, 
not what it cost him to build up, but the capitalised value 
of its earning capacity. 

The second important element in profits is payment 
for undertaking risks, especially the risks involved in 
anticipating demand and supply. It was shown in Chapter 
IV. that risks are unavoidable in a society that avails itself 
of the economies of the division of labour. The division 
of labour involves production in anticipation of demand, 
and fluctuations in the volume of the supply of raw material 
are constantly changing the value of a commodity between 
the commencement of the process of production and its 
completion. Further, it is impossible to anticipate cor- 
rectly in every case what the demand will be ; whenever 
a mistake is made in this anticipation, whenever the public 
want less of one thing and more of another, or something 
different from what has been made, there is a loss. The 
thing made does not fetch the price anticipated, and the 
owners of the business that made it bear the loss. They 
can bear this loss, because at other times they have made 
just what turned out to be wanted and got a good price 
for it. Profits are big when the managers of businesses 
anticipate correctly what the public want and will pay for, 
losses are incurred when their anticipations are incorrect ; 



XVIII INTEREST AND PROFITS 337 

in the long run the profits must exceed the losses, or the 
business cannot continue. 

Profits act as a sort of buffer between prices on the 
one hand, and interest, wages and rent on the other. 
Prices fluctuate owing to changes in the supply of raw 
materials and in the demand for finished products ; 
the worker, capitalist and land -owner want a steady 
price for their labour, capital and land ; the owners 
of businesses give them a steady price — regular wages, a 
uniform rate of interest, a uniform rate of rent, and take the 
price of the commodity made, making big profits if the 
price obtained for the output as a whole is good, and small 
profits or losses if the price obtained is bad. That it is the 
owners of businesses who take the chief risks is clear when 
we remember that they have paid for the labour, capital and 
land before the commodity is finished, often before its price 
can be known, and if the commodity when made is not 
wanted and cannot be sold, they cannot recover the wages, 
interest and rent expended in the production of it. As we 
have seen, there is a tendency to separate the work of organis- 
ing or managing production from the taking of risks. The 
management of businesses is put into the hands of managers 
and managing directors, paid, Uke foremen, a regular wage 
or salary ; the risks of the market are borne by the owners 
of the businesses. In the most highly organised trades the 
separation is carried further. The businesses engaged in 
manufacture are relieved of the risks of the market, they 
work only on contract or commission, and the middlemen 
for whom they work specialise in the taking of risks. 

A third important element in profits is the income to 
be gained from any advantage over competitors ; for any 
such restriction on competition prevents competition from 
beating down selling price to cost of production. When 

z 



338 ECONOMICS chap. 

sellers compete freely and methods of production do not 
vary much from firm to firm, the price that any can get for 
their product will be kept close to their cost of production ; 
the firm that tried to raise its price would simply drive its 
customers to other firms which were content with a smaller 
profit over cost of production. If, however, one firm in a 
trade has some advantage in production shared by none 
of its competitors, it can get the same price as they do for 
the product, and, producing cheaper, make a larger profit. 
So important are the variations in productive efficiency of 
different pieces of land that the income derived from land, 
rent, is usually treated separately from the income derived 
from capital ; but " the rent of land," in Dr. Marshall's 
words, " is seen, not as a thing by itself, but as the leading 
species of a large genus." ^ Any process, machine or 
material which cheapens production gives its users a 
differential advantage in production and enables them to 
draw a " rent," so long as its use is restricted to a minority 
of the firms in the trade. The desire for such profits is the 
chief stimulus in modern industry to the improvement of 
organisation and the invention of new processes. 

Similarly anything of the nature of monopoly enables 
the monopolist to draw profits above the average. Since 
buyers must come to him, he need not fear competitors, 
and is not compelled therefore to keep his price near cost 
of production. A patent is such a monopoly. To secure 
such monopoly, however limited, is the chief object of 
advertisement. The advertiser aims at so impressing the 
consumer's mind with the desirabihty of his article that the 
consumer will insist on having it, and will refuse all sub- 
stitutes ; then he exploits this conviction in the consumer's 
mind by charging more for the article than he could do 
^ Principles, 6th edition, p. 412. 



xvni INTEEEST AND PROFITS 339 

if the consumer were not so determined to have it. A 
well-knoAvn brand or trade-mark, the reputation of an old- 
estabhshed firm, a prominent situation in an important 
street, a special flavour in a cocoa, tobacco or snufi, all 
enable the seller to obtain from the consumer a higher 
price than he could otherwise command, because the con- 
sumer does not adopt his usual practice of beating down 
prices by playing off one seller against another. The " good- 
will " of a firm consists in the limited monopoly the firm 
has of the custom of a section of the consuming public. 
The entangling of a poor customer in debt is a common 
device to secure the monopoly of his custom. All these 
devices have it for their object to restrict competition, and 
so to escape the pressure which it exerts, forcing prices 
down towards the cost of production. 

In addition to interest, then, there are three important 
elements in profits : payment for management and organisa- 
tion ; payment for undertaking risk ; and the revenue that 
can be derived from any restriction on competition. The 
profits of a firm may consist of one or two of them, or it may 
include all three ; moreover, profits may or may not include 
interest. In every case profits are the portion of the 
revenue of a business which goes to the owners, and are 
arrived at by deducting total expenses from total receipts ; 
but expenses include different elements in the case of 
different types of firms. In the case of a private firm 
working entirely on borrowed capital, interest on capital 
will be an expense and will form no part of the profits ; 
in the case of a private firm working on its own capital 
entirely, interest on capital will form a large part of the 
profits. In the case of a joint-stock company, interest on 
debenture capital is treated as an expense and does not 
appear as an element in profits, while interest on ordinary 



340 ECONOMICS chap. 

share capital is not kept distinct and so forms a part of the 
profits, which are distributed to the ordinary shareholders 
as dividends. Again, in the case of management, the 
proprietor of a private firm may pay himself no salary — 
in the case of a small firm it is very unlikely that he will — 
and payment for management becomes an important 
element in profits. In a joint-stock company all payment 
for management is made in the form of salaries and regarded 
as an expense, so that it forms no part of profits. Payment 
for the bearing of risk and the revenue derived from restric- 
tions on competition cannot be so easily distinguished 
from the other elements in the revenue of a business, and 
are always drawn by the owners of the business as profits. 
It is important to bear in mind these different elements 
in profits when we come to compare profits in different 
industries or occupations. The rate of dividend on capital 
is not the only thing to be considered. We must consider 
the difficulty and amount of work required to manage the 
different industries ; we shall expect profits to be much 
higher in proportion to capital in a merchanting business 
that turns over its capital half a dozen times in a year, than 
in a railway that turns over its capital only once in ten years. 
We must consider the risks of the industry ; if risks are 
great we shall expect the rate of profit, when profits are 
made, to be high, in order to counterbalance the occasional 
losses which the nature of the business makes inevitable. 
To get the true rate of profit, we shall take the average 
earnings of a business for a number of years, and we shall 
deduct from the profits of successful firms the losses of un- 
successful firms. We must also know whether the trade ia 
new ; if it is new, apparent profits will be higher than they 
will become later, for three reasons : the risks of a new 
industry are less understood and the chances of loss there- 



xvm INTBEEST AND PEOFITS 341 

fore greater ; the work of organising a new business requires 
greater ability than the work of running an old one, and com- 
mands, therefore, a higher remuneration ; and the number 
of firms in a new industry will naturally at first be insufficient 
to meet the demand. The period of high profits in a new 
industry is usually preceded by a period of imremunerative 
expenditure on experiments, advertisements, etc., and 
followed by a period of depression, owing to the over- 
production which the high profits induced ; finally, the trade 
settles down, and supply is so adjusted to demand that the 
trade as a whole makes profits which are neither exception- 
ally high nor exceptionally low. In comparing the profits 
of different firms in the same trade, we shall look chiefly 
to the ability of the management, especially in the matter 
of anticipating demand and supply ; but we shall also look 
to see what firms have difierential advantages in production, 
and what firms partial monopolies. 

II 

Why is Interest paid ? 

Profits, then, include other elements besides the earnings 
of capital ; interest is simply the " earnings " of capital. 
Interest presents us with two problems : (1) why is interest 
paid, and (2) what determines the amount of interest. 

There is, however, a preliminary difficulty, which we must 
consider first ; apparently capital earns different rates of 
interest in different employments. Pawn-brokers charge 
interest at the rate of 25 per cent to 50 per cent on their 
loans ; governments borrow money at the rate of 3 per 
cent to 3| per cent ; municipalities pay a little more ; banks 
pay a low rate of interest on deposits, but charge bill- 
brokers and stock-brokers even less ; ordinary stock in a 



342 ECONOMICS chap. 

company usually receives interest at a higher rate than 
preference shares, and preference shares than debentures. 
Why this variation ? The explanation is that " interest " 
in some of these cases includes elements that should strictly 
be called " profits," and in all the cases allowance is made 
for risk of non-payment of interest or loss of principal. 
The pawn-broker charges in the form of interest for his 
labour in managing his business and the trouble he will be 
put to in selling the pledge if the loan is not repaid ; the 
bill-broker gets his loan cheap, because he reheves the bank 
of some of the work of finding investments for its funds, 
and because he takes the loan on extremely inconvenient 
terms as to repayment. In the other cases the rate of 
interest varies simply with the risk run ; the rate is lowest 
when the security for interest and repayment of principal 
is greatest. 

An answer to our first question, why is interest paid, 
is necessary if we are to answer our second question, what 
determines the amount or rate of interest. Interest is paid 
for the same reason as all other payments are made, because 
a loan confers a service ; there are always people willing 
to pay interest, because a loan will enable them to satisfy 
their wants. The service rendered by the loan varies with 
the use to which it is put ; there always is a service, because 
a loan is a loan of wealth, and gives the borrower for the 
time being the same command of wealth as ownership gives. 
A loan is usually spoken of in terms of money — a loan of 
£1000 or whatever the sum may be— but money only 
measures the amount of the loan ; what the borrower wants 
and gets is the goods and services that the money buys. 
Neglect of this truth has led many people to ignore the true 
nature of a loan ; in the Middle Ages no objection was made 
to payment for the use of a house or land (rent), but pay- 



xvni INTEREST AND PROFITS 343 

ment for tiie use of money — which was only wanted in 
order to buy a house, land, or some other form of wealth — 
was called usury and made illegal. The essence of a loan 
is that the borrower gets the use of some of the lender's 
wealth, and can derive from it all the satisfactions and 
services that wealth gives ; for this he is willing to pay. 
The simplest way of regarding interest is as payment for 
the use of wealth, which the owner could use himself if he did 
not lend it to the debtor. 

The commonest use to which a loan is put to-day is to 
assist production. With the money borrowed buildings are 
erected and machinery bought. By the aid of these imple- 
ments of production the business man, who obtained the 
loan, and his staff of workers, are enabled to produce far 
more than they could have done without these implements ; 
they are willing therefore to pay a portion of the product 
to the lender of the implements. If no medium of exchange 
were in use, and payments for services were all made in 
kind, then out of every piece of cloth made a portion would 
go to the weaver as wages, a portion to the capitalist who 
advanced the loom as interest, a portion to the owner of 
the land and buildings, which housed the loom, as rent, and 
smaller portions to all the foremen, managers, enginemen, 
etc., whose work is needed in a weaving factory, a portion to 
the firms which supplied the yarn, coal, etc., the residue 
going to the owner of the business as profits. Similarly in 
the engineering shop where the loom was made a portion of 
the cloth given in exchange for it would go to the labourers 
making it, a portion to the owner of the machines which 
these labourers used, and so on. In every act of production 
in modern industry, manual work, organising work, capital 
in the form of machines and power plant, and land, co- 
operate and, because they co-operate, share in the product. 



344 ECONOMICS chap. 

Interest is paid for the use of capital, because the capital 
is productive ; it enables its user to produce more than he 
could without it, and out of this additional product interest 
is paid. Where the capital is misapplied so that it produces 
nothing, either the profits of the business are drawn upon 
to pay interest on it, or, as is very often the case, no interest 
is paid. 

A loan of wealth, obtained for purposes of production, 
may be of assistance to the borrower in a different way, 
and so induce him to offer interest for it. It enables him 
to get finished goods which will tide him over the time 
between the beginning of the manufacture of a commodity 
and the sale of the finished commodity. By getting the 
finished goods that he needs for daily use and consumption 
now he is enabled to take his time over production, and 
thereby produce more. He can adopt a system of very 
extensive and detailed division of labour, which makes 
manufacture round-about and lengthy, but very productive ; 
by being enabled to wait, he is enabled to produce more, 
and out of the additional product he can pay interest. It 
pays him, therefore, to offer to repay in the future, when he 
will have completed the productive operation for which he 
needs the loan, the whole sum advanced and interest in 
addition, if by so doing he can get money to buy the finished 
goods and the services that he needs immediately, A 
people that has no capital is forced to live from hand to 
mouth, and, being unable to carry the division of labour far, 
is materially poor. 

Not all loans are obtained for productive purposes. The 
most eager borrowers are individual spendthrifts and 
governments at war. They offer interest, though the loan 
will not enable them to increase their incomes and so pay 
the interest ; they are simply mortgaging future resources 



xvm INTEREST AND PROFITS 345 

to satisfy present wants. Why do they do so ? Their 
motive is the intensity of their present need. The spend- 
thrift is intensely conscious of his want of money now ; 
he does not realise with anything like the same intensity 
that he will probably want money just as much in the future, 
when he has to repay the loan ; he probably thinks that 
something will " turn up " before then. Any one, therefore, 
who will supply him with money 7iow is doing him a service 
for which he is willing to pay. Similarly the Chancellor 
of the Exchequer must have money for his war — even a 
nation of shop-keepers never considers expense in deciding 
about war — he risks great unpopularity if he imposes any 
further taxation now ; on the other hand, loans will have to 
be repaid by future generations, and a statesman incurs no 
unpopularity by throwing on to the shoulders of future 
generations the obligations incurred by his own ; he there- 
fore " finances " his war by a loan. 

In every case interest is offered because a loan confers 
a service ; for the same reasons the lender expects to receive 
interest. By making the loan he gives up the use of a 
portion of his wealth ; he expects compensation. It is 
not enough that he will get back his wealth some time in 
the future ; meanwhile he is being deprived of the satis- 
factions he could have got from its use. If the borrower 
uses the loan to purchase instruments of production, the 
lender expects a share of the product, since he himself, if 
he had not made the loan, could have purchased instruments 
of production. If the borrower uses the loan as circulating 
capital, the lender expects payment for this service also. 
Finally, he wants some interest to induce him to save. Most 
people prefer spending the whole of their income to saving 
a portion of it ; present wants appeal to them more strongly 
than future wants. " A bird in the hand is worth two in the 



346 ECONOMICS chap. 

bush " ; the promise of £100 a year hence, even if we have 
absolute faith that the promise will be fulfilled, is not the 
same to us as £100 now. £100 a year hence will probably 
give us as much satisfaction as £100 now, but we do not 
realise that. We discount future satisfactions, and we 
require therefore some inducement to postpone satisfactions 
to the future, which is what saving means. Society needs 
capital ; capital is not provided free by Nature in unlimited 
quantities like air ; society therefore has to pay people to 
induce them to accumulate capital, and interest is the 
payment. 

Ill 

What determines the Rate of Interest ? 

We can now approach the second question. What 
determines the amount or rate of interest ? Interest is the 
" value " of the use of capital, and, like any other value, 
depends on the relation of supply to demand, and in answer- 
ing the first question, why interest is asked and paid, we 
have reviewed the influences that control the supply of 
capital and the demand for it. The supply depends on the 
willingness and ability of people to sacrifice present to 
future satisfactions ; the demand depends on the produc- 
tivity of capital, and on the intensity of present need that 
induces people to mortgage future income in order to secure 
an increase of present income. 

The willingness of people to save is largely a matter of 
social habit, the ability to save depends on the amount and 
distribution of wealth. Saving always involves a sacrifice 
of present for future satisfaction ; to individuals and com- 
munities who are poor the sacrifice is great ; to individuals 
and communities who are rich it is small, and may even 
become negligible. So long as there is any sacrifice involved 



xvin INTEREST AND PROFITS 347 

in saving, the supply of capital will always be less than the 
possible uses of capital, and interest will be necessary to 
keep up the supply. What influence changes in the rate 
of interest (or value of capital) have on the supply of capital 
is uncertain. A rise in the general rate of interest may in 
some cases induce an increase in the supply of capital ; 
usually, however, it will probably have no such effect. The 
accumulation of capital is due mainly to two classes of 
savers : one class, the prudent or timorous people who are 
anxious to secure a certain income from investment, will 
need to save less to secure this certain income if the general 
rate of interest goes up, and will save more easily and 
rapidly ; the other class, people engaged in business, who 
are anxious to increase the size of their business and there- 
fore leave in the business each year some of its earnings, 
will be unafiected by the level of interest. In the latter 
class is included the important section of the community 
which, being determined to get rich at any cost, spends as 
httle as it can and saves as much as it can, whatever the 
rate of interest. A change in the rate of interest in some 
particular industry, as distinct from a change in the general 
rate of interest, does affect the supply of capital in that 
industry. Capital is constantly wearing out and has to be 
renewed from gross income ; it will not all be renewed if 
the rate of interest in the industry falls below the known 
rate of interest in other accessible industries. On the other 
hand, if the rate of interest in an industry is high, new 
capital will be attracted into the industry, because there is 
always a fund of capital awaiting investment which will 
be directed into the industry that seems to offer the biggest 
net return on the investment. 

Of the influences that affect the demand for loans, the 
productivity of capital is the chief ; the need of individuals 



348 ECONOMICS chap. 

and governments for unproductive expenditure, though 
still of enormous importance, no longer normally controls 
the market for loans as it did before the nineteenth century. 
The productivity of capital is difierent in different countries 
and at different times. Capital is always used in co-opera- 
tion with labour and natural resources, and as their relative 
proportions vary the productivity of each varies. If the 
amount of capital available for industry increases without 
any corresponding increase in labour and natural resources, 
capital can be fully employed only if it is put to uses in 
which it is less productive than it was before. On the other 
hand, if labour or natural resources increase relatively to 
capital, capital will become more productive, because it 
will now be withdrawn from the uses in which formerly it 
was least productive and be restricted to its more productive 
uses. The organisers of industry, balancing labour capital 
and natural resources against one another in order to find 
exactly the most productive combination, employ just as 
much capital as at the current rate of interest gives them 
a profit. Hence the rate of interest and the demand for 
capital are connected both in industry as a whole and in any 
single industry ; a change in one produces a change in the 
other. If a little more capital will enable an organiser to 
produce more or more cheaply, he will offer more for it, i.e. 
the rate of interest will go up ; conversely, if the rate of 
interest falls, he will employ a little more capital. It is 
always the productivity of a little more or a little less 
capital that the organiser considers, and economists there- 
fore speak of the " marginal " productivity of capital. The 
competition of lenders and borrowers in the money market 
tends to make the rate of interest coincide with the marginal 
productivity of capital ; in other words, the rate of interest 
depends on the relation of the supply of capital to the 



xvm INTEEEST AND PROFITS 349 

demand for it, and the supply and demand influence each 
other. 

The demand for capital is explained in a different way 
by those economists, such as Marx, who hold the Subsistence 
Theory of Wages. Capital, they argue, is necessary for 
any productive work to-day ; the owners of it, therefore, 
are able to force the labourers to work in return for a sub- 
sistence wage, and to take for themselves the rest of the 
product of industry. We have seen reasons for believing 
that wages to-day are not subsistence wages, and the theory 
seems to assume that all the owners of capital act together 
in industry as a class. If they did, the theory would be 
correct ; but they compete, both to sell products and to 
buy labour, far more than they combine, and by competing 
are forced to give to the labourer more than a bare sub- 
sistence. This Exploitation Theory has, however, important 
elements of truth. It calls attention to the enormous social 
power given, especially in countries which are nominally 
democracies, by the possession of capital. It reminds us of 
the weakness, in a s6ciety which allows the values of s^ervices 
to be settled by the relations of supply and demand, of 
those members of society who have no reserve of wealth. 
And it reminds us of the historical origin of at any rate 
much of the capital in use at the present day. Capital 
in England has not too creditable an ancestry, for three of 
the chief sources of its growth are the private appropria- 
tion of land-values created by the growth of towns, the 
exploitation of slaves and Asiatics in the seventeenth and 
eighteenth centuries, and the exploitation of child labour 
in the first half of the nineteenth century. 



CHAPTEE XIX 

RENT 
I 

The Ricardian Theory of Rent 

The theory of Rent was given its present importance in 
Economics by Ricardo and his followers. They held that 
the value of a thing is fixed by its cost of production ; they 
sought to apply this theory to agents of production, i.e. to 
find in the cost of production of land capital and labour 
the principle on which the present distribution of income 
between owners of land capital and labour is based. 
Hence they said that wages depended on subsistence, i.e. 
on the " cost of production " of the labourer ; interest 
was the payment needed to induce people to save, it was the 
" cost of production " of capital. When they came to land, 
they could not adopt this explanation. They were struck 
by the obvious fact that land, although it has to be paid for, 
has no " cost of production " ; man does not " produce " 
it, it is there before he is, and would still be there if the owners 
of it received nothing for its use. They had therefore to 
seek another principle to explain why rent is paid and how 
the amount of rent is fixed. They found their principle in 
the natural variations in the productivity of land, coupled 

350 



CHAP. XIX RENT 351 

with the fact that the most productive land is Hmited in 
quantity. 

Some land will not repay cultivation ; crops could be 
raised on it, but the price they would fetch would not be 
enough to repay the expenses of raising them. Other land 
will just repay the expenses of cultivation, but nothing 
beyond ; the value of the produce is not enough to enable 
the farmer to pay any rent ; this land was said by Ricardo 
to be on "the margin of cultivation." Some land, however, 
is so fertile that the value of its produce is more than enough 
to pay the usual rate of wages to the labourers employed 
on it, the current rate of interest on the capital applied to it, 
and the average profits to the farmer cultivating it ; this 
surplus oi product over expenses, according to the theory, is 
taken by the owner of the land as rent. Competition for 
land among farmers enables owners to secure this surplus, 
due not to any effort on the part either of cultivator or 
owner, but to the superiority of the land over the land which 
only just repays cultivation. Once it is in the market one 
quarter of wheat fetches the same price as any other quarter 
of the same quality, whatever its cost of production. If 
the natural fertility of the soil on which it was grown made 
the cost of production low, the saving would go to the owner 
of the soil ; if the soil was infertile or difficult of access, so 
that the cost of bringing the wheat to market usually 
equalled the price it fetched, the owner of the soil would 
be able to get nothing for the use of his land. 

Variations in productivity may be due to the differing 
fertility of different pieces of land or to varying advantages 
of situation. Just as a given application of capital and 
labour will give a larger return on some soils than others, 
so will a given application of capital and labour to shop- 
keeping give a bigger return on some sites than others. The 



352 



ECONOMICS 



same liat will sell for a bigger price in Bond Street than in 
New Oxford Street ; more business can be done with a 
given capital in the middle of London than in the middle of 
Westmoreland. In every case the owner of the better 
site can secure the additional value given to the wares of a 
shop by its situation or the value of the additional facilities 
afforded to a business by a central position. The con- 
venient situations for offices, factories and shops, like fertile 
land for agriculture, are limited in quantity ; people who 
want them have to pay for them in proportion to their 
convenience. 1 



^ The nature of rent can be illustrated by a diagram : 
E F 



N 


G H 




K L 









A 



B 



Suppose AB, BC, CD are pieces of land of equal extent, managed 
with equal ability and with the same appHcation of capital and labour 
and producing wheat for the same market ; owing to differences in 
the fertility of the soil the product is diiJerent in each case, the 
product of AB being represented by the rectangle AEFB, that of 
BO by the rectangle BGHC, and that of CD by the rectangle 
CKLD. If the market needs the produce of the inferior land CD, 
the price for the amount of corn represented by CKLD will have 
to be sufficient to repay his expenditure in capital and labour to the 
farmer who worked the land ; otherwise he will be driven out of the 
trade and the land will go out of cultivation. Now the same amount 
was expended on the other pieces of land ; therefore the other 
farmers will be fully repaid for their expenditure when they have sold 



KENT 



353 



II 

The Law of Diminishing Returns or Increasing Cost 

Increasing the area of land under cultivation is not the 
only way in whicli an increased supply of agricultural 

the same amount of corn as was raised on CD. When they have been 
fully repaid, therefore, they ■will stiU have an amount of corn repre- 
sented by the rectangle EFNM and GELKN to sell, i.e. this land 
gives a surplus over the amount of produce necessary to pay the 
cost of raising it. This surplus is rent and goes to the owner of the 
land. Or take this second diagram : 

K L 



G H 




E F 




' 







A B C D 

AEFB measures not the produce of a given expenditure of capital 
and labour but the expenditure needed to produce 100 quarters 
of wheat on AB. Then BC, being less fertile, wiU require a bigger 
expenditure (BGHC) to produce the same amount of wheat, 
and CD a greater expenditure stiU (CKLD). The price of 100 
quarters must cover the expenditure on CD ; therefore it will more 
than cover the expenditure required to produce the same amount on 
BC and AB. The difference will go to the owner of the land as 
rent. Similar diagrams would illustrate the nature of site-rents, 
receipts per £ of expenditure being substituted for product in wlieat, 
and the expenditure needed to secure, say, £100 of business being 
substituted for expenditure required to produce 100 quarters. 

2 A 



354 ECONOMICS chap. 

products can be obtained. An additional expenditure of 
capital and labour on the area already under cultivation 
will always increase the product. This fact, however, does 
not prevent the phenomenon of rent, because it does 
not prevent recourse to inferior or less convenient soils. 
Additional expenditure on land already under cultivation 
will produce an increased yield, but the increased yield 
will not be proportionate to the increased expenditure. 
This is the Law of Diminishing Eeturns or Increasing Cost, 
on which Malthus based his gloomy views of the future of 
society. Successive equal " doses " of capital and labour 
applied to land under cultivation, after a certain point in 
the cultivation of land has been reached, produce a diminish- 
ing return per " dose " ; or, to state the same principle 
difierently, equal increments of product can be obtained 
from the same land by the same methods only at increasing 
cost. The principle is only true assuming no improvement 
in the mode of cultivation, i.e, that successive " doses " 
are applied in the same form. The result of this principle 
is that different portions of the capital and labour employed 
on the saine land produce different returns. There is an 
" intensive " as well as an " extensive " margin of cultiva- 
tion, namely, that expenditure on the land which just " pays " 
at the market price of the product. Now if the market 
price just pays the expenses of raising this last increment 
of the crop, the portions of the crop raised with previous 
applications of labour and capital — being raised when the 
soil was not so near exhaustion — will afford a surplus over 
cost of production. They will sell for the same price as 
the last increment, but their cost of production, owing to 
the unexhausted vigour of the soil, will be less. The 
difference can be got by the owner of the land as " rent," 
since the tenant, if he objects to paying the rent, cannot 



XIX KENT 355 

secure any better return to his capital and labour in any 
otter way ; the return to his capital and labour will be less, 
whether he devotes it to the further working of good land 
already under high cultivation, or to working additional 
but inferior land not yet cultivated with equal intensity. 
The principle of Increasing Cost is of course the reason why 
society does not raise all its food by the intensive culture of 
selected land of special fertility. 

Hence the two processes, increasing the area under 
cultivation and increasing the expenditure of capital and 
labour on the same area, go on simultaneously and have the 
same result ; they mean an increased cost of production 
per unit of product on the margin of cultivation, they 
enable the owners of the land on which production is cheaper 
to take the difference as rent. As population grows, the 
margin of cultivation recedes and rents rise. 

This law of Increasing Cost is not noticed, because its 
effects are constantly being counteracted by two influences. 
Improvements in transport enable crowded countries to 
draw on the resources of distant lands, and improvements 
in methods of agriculture are constantly enabling us to 
obtain additional supplies from the same area without in- 
creased cost or even at a less cost. The construction of the 
Suez Canal enabled England to import from India wheat 
which would not stand the longer voyage round the Cape. 
The railways of North America brought within reach of the 
English market the virgin soils of the Middle West. Simi- 
larly the gradual adoption of the four-course rotation of 
crops by English farmers in the late eighteenth and early 
nineteenth centuries enabled them to carry much more 
stock on their land than had been possible before. There 
is a constant race, as population grows, between science and 
this tendency of nature to give increased supplies only at 



356 ECONOMICS chap. 

greater cost ; since the middle of the nineteenth century 
the advantage has rested with science. 

Site-values are subject to a tendency similar to the law 
of Increasing Cost in agriculture. Existing sites can always 
be improved, but at increasing cost. The cost of improve- 
ments in the centres of large towns illustrates this tendency ; 
more use is got out of the same extent of land as a result 
of the improvements, but the cost is greater and greater as 
the size of the towns increases. Additional stories can be 
added to existing buildings to save the expense of buying 
new sites, but the additional accommodation thus obtained 
is either less convenient than that of the lower stories, or, 
if equally convenient, is more costly. Improvements in 
means of transport and communications act as a check on 
this tendency towards increasing cost in sites, by extending 
the area over which the relations of a business centre can 
be effectively maintained. Improvements in methods of 
construction enable more efiective use to be made of sites 
already in use, just as advances in agricultural science enable 
increased produce to be obtained from soils already under 
cultivation. 

Ill 
Bent and Cost of Prodiiction 

Kent, then, is due to difierences in the productivity of 
difierent pieces of land, the users of which are working for 
the same market, difierences over which the owners have 
no control. From this the corollary is drawn that rent does 
not enter into the cost of production. " Corn," in Ricardo's 
words, "is not high because a rent is paid, but a rent is paid 
because corn is high ; and it has been justly observed that no 
reduction would take place in the price of corn, although 
landlords should forgo the whole of their rent." The 



XIX KENT 357 

latter part of Ricardo's statement is not strictly accurate. 
If the landlords would forgo their rents, not to their 
tenants but to the State, the State could, as it were, pool 
all the land of the country, and sell the corn raised on the 
worst lands below its cost of production, compensating 
itself from the surplus of product over outlay on the best 
lands, i.e. rent as a whole enters into cost of production 
as a ivhole, prices as a whole would be lower if no rent were 
paid ; but any particular rent does not affect the price of 
the product of the land for which it is paid, it depends on 
that price. Ricardo, however, had in mind not the State 
but the tenant, and for landlords to forgo their rent to 
their tenants would not relieve the consumer. The surplus 
of product over outlay on land that was within the margin 
of use would remain, being something for which neither 
land-owner nor land-user is responsible. Under the system 
of private ownership it is true to say that rents depend upon 
prices, not prices upon rents. 

The difficulty that is usually experienced in grasping this 
principle is due to the difference between the individual 
and the social point of view. Most people look at rent from 
the point of view of the individual. They see that the 
farmer regards his rent as a cost, a payment made for so 
much productive power, just as much as the interest he 
pays on borrowed capital or the wages he pays for labour ; 
he has to insist on a price for his output sufficient to enable 
him to pay rent, as well as interest and wages, or he cannot 
continue farming. His rent is a part of his cost of pro- 
duction, which determines the minimum price he can 
take for his total produce. From the point of view of 
society, however, we are not concerned with the price which 
the farmer must charge for his whole output, but with the 
minimum price for which a quarter of wheat can be got, 



358 ECONOMICS chap. 

and the minimum depends, not on tlie cost of production 
oi a quarter of wheat on land which pays a rent, but on 
the cost of production on land which only just repays the 
expenses of working without affording any surplus for rent. 
It is this part of the total produce coming to market which 
fixes the minimum price society must pay, because society 
will not have all it wants without this part, and this part 
will not be produced if the price falls below this minimum. 
The produce of better land costs less to produce ; it is sold 
at the same price per quarter or ton ; the saving due to the 
superiority of the land goes to the owner of the land as 
rent. His rent is the result of the high price ; the actual 
expenditure on labour and capital on his land does not 
affect the market price. What the tenant of the better land 
pays in rent is balanced by the increased amount of produce 
which he gets owing to the superior fertility (or accessibility) 
of his farm. Farmers with equal capital and skill but less 
fertile or accessible land get less produce from their land ; 
they get no bigger price for the quarter of wheat, but can 
make the same net income, because their smaller output is 
balanced by the lower rent they pay for their less fertile 
or accessible land. From the point of view of the individual, 
rent is an element in the necessary cost ; he must be able 
to meet it or he cannot continue in his business ; from the 
point of view of society, it is not a necessary element, because 
the total amount of produce would not be diminished if it 
were not paid. The market-price is sufficient to remunerate 
the labour and capital employed on the worst land in use, 
and more than sufficient, therefore, to remunerate the labour 
and capital employed on the superior lands ; if no payment 
is made for the superior lands, their quantity and quahty 
will not be affected. Since land is largely in private hands, 
the owners are able to get payment for its use, but the 



XIX RENT 359 

payment they can get depends on the price which their 
tenants can get for the portion of the produce due to the 
superior fertihty of their land, the tenant simply handing 
over to the landlord the price he receives for the additional 
produce. 

This principle, that the productive powers for which 
rent is the payment are independent of payment, i.e. are 
not called forth by the ofEer of payment, and will not languish 
if payment be stopped, is of fundamental social importance. 
Prices depend on costs of production in the sense that unless 
the prices paid are big enough, on the whole and in the 
long run, to cover costs of production, goods will not be 
suppHed. The productivity of land for which rent is 
paid is not affected by the payment of rent. It is due to natural 
variations in soils, or to the varying advantages given to 
sites, not by the owners of the sites but by the distribution 
of population and the means of transport. If the payment 
of rent were stopped, the fertility of good soils, the con- 
venience of good sites, would not diminish ; for the rent- 
receivers did not cteate, and do not maintain, that fertility 
and that convenience. They might, as a matter of tactics 
or from a "dog-in-the-manger" temper, withhold their land 
from use ; but they would do themselves no good by so 
doing. If wages are not paid, on the whole people will not 
work ; if interest is not paid, on the whole people will save 
less ; if rent is not paid, the quantity and quality of land 
will not be affected. Wages have to be paid by society to 
maintain the supply of labour ; interest has to be paid to 
maintain the supply of capital ; the supply of land is not 
affected by the payment of rent. 



360 ECONOMICS chap. 

IV 

Application of the Ricardian Theory to Actual Conditions 

Before we develop the consequences of the Ricardian 
rent theory, however, we must pause to consider some 
difficulties in the application of the theory to actual con- 
ditions. The first difficulty is that the economist gives a 
meaning to the word " rent " different from its meaning in 
ordinary speech. In ordinary speech rent is the payment 
made for the use of any kind of real property ; Ricardo 
restricted the term to the payment made for the " original 
and indestructible qualities of the soil." Ricardo's justifica- 
tion is that " rent " in ordinary speech covers payments 
which are different in kind. The rent of a house includes 
interest on the capital embodied in the house and amortisa- 
tion, as well as payment for the use of the land on which the 
house stands. Similarly the rent of a farm usually includes 
a good deal of interest on capital, embodied in buildings and 
improvements, as well as payment for the use of the bare 
land. In England, where it is the custom for the landlord 
to provide most of the more permanent improvements, as 
much as five-sixths of the " rent " may be interest on capital. 
It is not too much to state that in an old country farm-land 
is " made," its present value being, as a rule, due hardly 
at all to any original fertility and almost entirely to the 
constant investment of capital in it. Clearing, draining, 
road-making, fencing have all to be done before the " original 
and indestructible qualities " can be utilised. 

Rent, again, in the sense in which the word is used in 
ordinary speech, occurs only when the holder of the land is 
not the owner. In Great Britain, where the theory of rent 
arose, the custom has been for a century and a half for land 



XIX RENT 361 

to be farmed by tenants, the owners of the land supplying the 
more permanent forms of capital, but not taking any active 
part in the work of cultivation. But this system of land- 
tenure is exceptional ; the vast majority of the world's 
farmers own the land they cultivate. But though no pay- 
ment is made for the use of the land where the owner 
cultivates, the surplus of product over outlay due to differ- 
ential productivity, which constitutes " economic " or 
" Ricardian " rent, occurs and goes to enrich the owner 
of the land. This pecuHarity of English agriculture has in- 
fluenced, one might say side-tracked, the course of economic 
studies. The economic condition of an agricultural popula- 
tion depends much more on the distribution of landed 
property than on the distribution of the income from land 
between rent-receivers, interest-receivers and wage-receivers. 
English economists, however, have given much more atten- 
tion to elucidating the latter problem than the former. 

A difficulty often experienced in studying the theory of 
rent is that, in Great Britain at any rate, there seems to be 
no land " on the margin of use," no " no-rent " land. Now 
there may be no land for which no rent is required in Great 
Britain, but such a consideration would not upset the 
theory of rent. The British market is served by lands 
outside Great Britain ; modern means of transport bring 
into competition with British corn the produce of every 
habitable continent ; so that the margin of cultivation for the 
British market may be in North- West Canada or Austraha 
or the Argentine. In Great Britain, where, on the whole, 
more capital and labour are applied and a bigger produce 
per acre is obtained than in any other country, the margin 
of cultivation would be an intensive not an extensive one. 
It is not, however, certain that there is no " no-rent " 
land in Great Britain. After allowance has been made for 



362 ECONOMICS chap. 

interest on the capital invested in permanent improvements 
on many English farms, there will be nothing left to represent 
payment for the " original and indestructible qualities of 
the soil." Again, land does not occur in compact blocks 
nicely graded. Land is let in farms, and every farm 
includes some good and some bad land. Payment is made 
at the rate of so much per acre, the acres of bad land paying 
something more than their economic rent, the good acres 
something less. Because good and bad are usually combined 
in this way, it is possible to quote a normal " rent per acre " 
for a whole district, that being the rate at which most of 
the tenant-farmers in the district pay for their farms. 

It must not be forgotten that land has many uses, and 
there may be several " margins," without there being any 
" no-rent " land. Land may be " marginal " for building 
purposes and yet give a bigger return for a given expendi- 
ture of capital and labour than the same extent of land on 
the agricultural margin. It may be useless for agriculture 
and yet have a value for sport. In England, with its dense 
population, some use can be found for most land, and the 
values of land for different uses are curiously affected by 
the desire for land as a means of ostentation or sign of social 
status ; more will often be paid for land to keep it idle, in 
the form of a park, than would be paid for the same land for 
the purpose of wheat -growing or sheep - farming ; the 
" pheasant margin " may be higher than the " peasant 
margin." 

Finally, we have seen that fertility and site-value are 
relative to agricultural science and the means of transport. 
An improvement in either of these will effect a widespread 
change in the relative productivity of different pieces of 
land. The example usually quoted is the new value for 
wheat-growing given to sandy soils by the introduction of 



xis RENT 363 

turnips into the rotation of crops. Urban site-values in 
England have been greatly altered in recent years by the 
construction of electric tramways, tubes, etc. Science is 
constantly lessening differences and redistributing fertility 
and site-values. But differences remain, and give rise to 
economic rent, and the Ricardian theory, in spite of all 
these qualifications, remains important. 



CHAPTER XX 

RENT {continued) 

I 

" Rent " Elements in Wages 

Rent, in ordinary speech, is the payment made for the use 
of real property. We have, however, seen that the essential 
characteristic that distinguishes rent from other forms of 
income is that it is the outcome of differences which are 
not due to owner or user, and are therefore independent of 
the payment made to them. From the point of view of the 
payer of rent there is no difference between Land and the 
other agents of production. Labour and Capital. Farmers 
regard their rent as a payment that must be made if they 
are to carry on their business, precisely in the same way as 
the payment of wages for labour, or interest on borrowed 
capital. Manufacturers regard any rent they pay for the 
site of the mill as a cost like any other cost. The important 
question for the entrepreneur is, " How shall I get most 
productive power for my money ? " and he expends his 
resources (derived ultimately from the sale of his products) 
on land, labour or capital according as each increases their 
output. He needs all three, it is always a matter of a little 
more or a little less of each ; so that we may say, if we like, 
that it is their " marginal " productivity that determines his 

364 



CHAP, xs RENT 365 

employment of them, and therefore their value. From 
this point of view there is no difference between Land, 
Labour azid Capital ; each is paid for on account of its 
productivity, and, if we grant the rather large assumption 
that the bargaining powers of land-owners, workers and 
capitalists are equal, we may say that each is paid in pro- 
portion to its productivity, i.e. to the aid it gives in the pro- 
duction of value. Land, from the side of demand, is simply 
a requisite of production, paid for in accordance with its 
productivity. It is on the side of supply that the differences 
between land and the other agents of production occur, and 
the theory of rent is emphasised most by those economists 
who, like Ricardo, approach all questions of value, including 
the value of the agents of production, from the side of 
supply. 

Now the rent of land is the most obvious, but not the 
only, case in which an income is derived from differences in 
the productivity of an agent of production which are not 
due to the persons who supply that agent of production. A 
similar element can be discovered in incomes derived from 
work and incomes derived from capital, if these incomes 
are approached from the same side as Ricardo approached 
income from land, namely, the side of supply. The 
phenomenon of economic rent is most clearly seen in the 
case of land, because it is possible to find " no-rent " land, 
on the " ma. gin of cultivation," which shows up the differ- 
ential productivity of " rent " land. It may be difficult to 
find any marginal labour or capital, but it is quite easy to 
find different levels of productivity in labour and capital, 
differences which are not due to the persons who supply 
the labour or capital, any more than differences in the 
fertihty of the soil re due to land-owners. The test of the 
existence of an element of economic rent in wages and 



366 ECONOMICS chap. 

profits is the same as in the case of land rent : Is the 
productivity of the agent evoked by and dependent on the 
payment for it, or is it unafiected by payment ? 

The case of labour may be taken first. It is easy to 
find important cases when quantity and quality of work are 
almost entirely independent of the payment made. Genius 
is such a case. The great quantity or fine quality of a 
genius's work is not evoked by the amount of payment ; it 
is due to the natural endowment of the genius, just as the 
fine quality of the products of Champagne vineyards is due 
to natural endowmento In most professions there is a 
standard income towards which most actual incomes 
gravitate and with which most members of the profession 
are satisfied. So long as they get this standard income, 
the best members of the profession work irrespective of pay- 
ment. Their motive is interest in their work ; the best 
work is done for the sake of the work. Great surgeons may 
charge a hundred guineas for a single operation, but they 
would exercise just as much skill if they could get only ten 
guineas ; the difference is a " rent," which represents society's 
valuation of the difference between the great surgeon's 
skill and the " marginal " surgeon's skill. The great 
surgeon takes it because he can get it, but he performs 
exactly the same operation for nothing in the voluntary 
hospital. Members of the Civil Service of the same grade 
do not all do the same amount of work ; they all receive 
the same pay, and one never hears of the hard or specially 
gifted workers among them demanding payment in propor- 
tion to their productivity. The same differences in pro- 
ductivity, without differences of payment, are common 
among manual workers. The manual worker, we have seen, 
like the professional man, demands his standard wage and 
does not worry much about anything more ; employers can 



XX RENT 367 

often induce him to increase liis output by, say, a sixth by 
an increase in pay of only a twelfth. No class of worker 
perhaps is indifferent to pay, but productivity is seldom 
strictly proportionate to pay. 

Variations in the productivity of workers are as great 
as variations in the productivity of land ; to a large extent 
the former are as little influenced by the prospect of pay- 
ment as the latter. It would be possible to frame a Theory 
of Wages parallel at all points with the Theory of Rent. 
Subsistence wages would represent the margin of production; 
the return equals the outlay and gives no surplus. Most 
workers, however, receive more than a bare subsistence. In 
one class of cases this is due to the investment of capital in 
the worker in the form of special training ; in this class 
wages correspond to the rent of farms on which there has 
been a large capital outlay in permanent improvements, 
producing a return apart from and above any " economic 
rent." In another class a surplus of wages over subsistence 
is earned because the natural endowment of the workers is 
exceptional ; such incomes have been called " Rent of 
Ability," and correspond to fertility rent in the case of land. 
There is a third class whose wages have an element corre- 
sponding to site rents in the case of land. This is the case 
of workers who owe the surplus of their incomes over 
subsistence to restriction of their number, owing to class 
distinctions, monopoly of educational opportunity, and 
similar causes. The " cost of production " of a doctor is 
not very much greater than the " cost of production " 
of a dustman ; allowance must be made for the capital 
expenditure on the doctor's training, but after interest on 
that expenditure has been allowed for, there remains a 
great disparity of income. This disparity would seem to 
be due to the fact that though there are any number of 



368 ECONOMICS chap. 

people witli brains enougli to make doctors as good as the 
average practitioner, only a small proportion of tliem have 
the opportunity of a medical training, so that the supply 
of doctors is, compared with the supply of dustmen, small. 
Such a theory of wages, reached by approaching the problem 
of the value of different kinds of labour, from the side of 
supply, is not inconsistent with the Marginal Productivity 
explanation of wages ; it is at least as successful in bringing 
out the socially important influences on wages. It directs 
attention to the inequality of social opportunity which is 
the chief cause of inequality of income, and it reminds us 
that much work — including most of the work that requires 
the finest and rarest qualities — is done from no economic 
motive at all, but in return for the interest and pleasure of 
the work, or from a sense of duty. 

II 

" Rent " Elements in Profits and Interest 

Difierent levels of productivity can be found in the case 
of capital also, equally unafiected by payment. The capital 
invested in land in so-called " permanent " improvements, 
once it has been so invested, gives a return fixed in precisely 
the same way as the rent of the land itself. The usage of 
ordinary speech which applies the term rent to the payment 
for any form of real property has a good economic basis. 
Drainage schemes, roads, fences, buildings, are all like 
agricultural land in this, that their value depends on the 
prices of agricultural produce, not vice versa. When English 
agricultural rents fell after 1879 the fall was not confined 
to " economic " rent ; it extended to all incomes derived 
from permanent improvements of land. Similarly the 
plant of an old firm often afiords an income indistinguishable 



XX RENT 369 

from rent. The income it affords depends on the price of 
its product ; if the price is high^ it will make a big income 
for its owner, but if prices fall it is not withdrawn from use. 
It will remain in use so long as the price affords any surplus 
over the bare expenses of labour, material, and wear and 
tear. When only the ordinary bare expenses are made by 
the sale of the product, it may be called " capital on the 
margin of production," or " no interest " capital. 

The return to all fixed capital, if a short period is under 
consideration, partakes of the nature of economic rent, i.e. 
it depends on prices, not prices on it. In the long run the 
price of the product has to aft'ord interest on the capital, 
or investment in the industry will cease ; similarly a rise 
in prices followed by a rise in the return to capital already 
in the industry will in the long run attract new capital into 
the industry ; but a fall in prices reducing interest can 
seldom affect the supply of capital in an industry for some 
time, and new capital cannot be put into an industry the 
moment a rise takes place. There is an interval while 
plant in existence is 'wearing out or new plant is being con- 
structed ; in that interval earnings of the plant in existence 
depend on prices ; the owners of that plant are like land- 
owners, they do not control the productivity of their 
property ; if prices are low, their property brings them in 
nothing, if high it brings them in much. The profits and 
losses of business enterprise are due largely to fluctuations 
in the earnings of invested capital in this interval between 
the change in the demand for the products of the capital and 
the adjustment of the supply of capital to the changed 
demand. We have said that in the long run the price paid 
for the services of an industry has to cover interest at the 
average rate on the capital invested in the industry, or new 
capital will be diverted from the industry and the supply of 

2b 



370 ECONOMICS chap. 

its services curtailed. Where, however, the original cost of 
the plant of an industry is high in proportion to the working 
expenses, and the plant takes a long time to wear out, the 
" long run " may have to be a very long run indeed for 
supply to be aSected, and the " short run," during which 
the return to the capital is governed by the same influences 
as the return to land, may be a long period of time. The 
United Alkali Co., for example, paid no dividend on its 
ordinary shares from 1896 to 1905. There are railways 
still working that have paid no dividend for a generation. 
The return to the capital invested in the drainage of Fen 
land in the seventeenth century is, and always has been, a 
rent of precisely the same character as the rent of land. 

Invested capital, then, like land, has different levels of 
productivity, independently of payment. There is reason 
also to believe that the flow of new capital, from which 
replacements and additions to invested capital are made, 
includes elements which are not influenced by the rate of 
interest ; in the last paragraph we were considering capital 
in an industry, in this we consider the supply of capital 
as a whole. The three chief sources of the accumulation of 
capital, we saw, are the savings of prudent people, who wish 
to provide for future contingencies, the increase of business 
capital by men who never draw out from their businesses at 
the end of the year the full amount of the year's earnings, 
and the " savings " of men so rich that they cannot spend 
their whole income. Now the action of all these classes is 
of the nature of habit or social instinct rather than reasoned 
calculation, and will not be affected by a change in the rate 
of interest. So far as the first class does calculate exactly 
what they will want in the future, a fall in the rate of interest 
will, as Dr. Marshall points out, lead them to save more, 
since larger savings now are needed to give, at the lower 



XX EENT 371 

rate of interest^ the required income in the future. The 
second class either adopt a conventional standard of ex- 
penditure and leave in their businesses all that is over, 
however much it may be, once this conventional expenditure 
has been met ; or they are anxious to get rich quick, cut 
their personal expenditure down to a minimum, and save 
as much as they possibly can, whatever the rate of interest. 
The third class can hardly help saving. It is true that the 
rate of interest controls the supply of capital in any particular 
industry, it is not true that it is the determining influence in 
the supply of capital as a whole. 

The difference, then, between the return to land and the 
return to labour and to capital is not so great as Ricardo 
suggested. The Ricardian analysis of rent can be applied 
to wages and to profits and interest. The difference 
between land, labour and capital in this respect is one of 
degree only. There is a difference. It is not, to repeat, 
on the side of demand ; the demand for all three agents 
of production is due to the assistance they give to pro- 
duction, and the payment that will be offered will tend 
to be proportionate to the amount of that assistance. 
The difference is on the side of supply and amounts to this, 
that the supply of different kinds of land is much less under 
the control of man than the supply of different kinds of 
labour or capital ; it is more difficult to increase the supply 
of land for a particular use than it is to adjust the supply of 
labour or capital to a change in the demand for them. The 
rise of each new generation gives an opportunity for theK 
readjustment of the supply of labour to changing needs, 
and this readjustment is always going on ; in much the 
same way the constant wearing out of capital and the 
accumulation of new capital enables a constant readjustment 
in the application of capital to changing needs. But the 



372 • ECONOMICS chap. 

difierence is one of degree only ; the supply of labour and 
capital are not entirely under the control of their owners, 
the supply of land is not entirely out of the control of man. 
" Capital " merges into land in practice ; an expenditure of 
capital on transport is equivalent to increasing the supply 
of land, and there is a continuous gradation from the return 
to an investment of capital on a drainage scheme, which 
is indistinguishable from land rent, to the extra return on 
capital invested in a stock of mourning goods when a death 
in the royal family creates a sudden demand for them. In 
each case the return depends on the price, the price does 
not depend on the cost of the capital ; in the case of the 
drainage scheme that will always be the case, since drainage 
schemes last as long as land; in the case of the stock of 
mourning goods the differential value soon disappears, since 
the supply of mourning goods lends itself easily to rapid 
expansion and contraction to meet changes in demand. In 
fact the Ricardian Theory of Rent is not so much a new 
explanation of land incomes, as a new approach to the problem 
of distribution as a whole. 

There is another aspect of rent of importance from the 
point of view of society. The rent of land is due to the 
superior productivity of some land over other ; and the 
superior land enables the user to obtain a bigger retm-n for 
the same expenditure of labour and capital. Now this 
bigger return may take the form of a bigger output, as in 
the case of fertility rent ; but it may also take the form, 
not of an increase in the output, but of an increase in the 
value of the same output — as in the case of the hat which has 
a value of five guineas in Bond Street, and only two guineas 
in New Oxford Street. The " productivity " for which 
rent is paid is not necessarily the same thing as output ; 
it is productivity of value, not productivity of wealth. The 



XX RENT 373 

capital and labour employed on the Bond Street site bring in 
a bigger return than the capital and labour employed on the 
other site^not because more hats are produced in Bond Street, 
but because each hat produced has a greater value than the 
same hat would have if sold anywhere else. This high value 
is due to the relative scarcity of Bond Street hats ; the 
number of Bond Street sites for milliners' shops is limited, 
the demand for Bond Street hats is very great, therefore 
Bond Street hats have a high value, and Bond Street sites 
for milliners' shops command a high rent. 

In every case of rent which we have considered, the > 
payment of rent is due to the limitation in quantity of the 
agent of production paid for. Fertile land pays a higher 
rent than infertile land because it is scarce relatively to the 
demand for it ; central position pays a high site-rent 
because in every town only a few sites are central ; excep- 
tional ability commands exceptional payment because 
exceptional ability is rare ; mourning goods, on the death 
of a member of the royal family, command a value far 
above their cost of production because they are scarce 
relatively to the suddenly increased demand for them. , In 
all the cases we have considered so far, however, this 
scarcity relative to demand is due to natm-e, the distribution 
of population, or changes in demand ; the scarcity has been f 
due to causes beyond the control of any individual. A 
definition of rent that would cover all the cases considered 
so far is, " Rent is the payment made for an agent of pro- 
duction which has a scarcity value due not to the owner or 
user of the agent, but to natural or social causes beyond any 
individual's control." Scarcity, however, may be artificial ; 
the supply of a commodity or a service may be deliberately 
restricted when the supply can be controlled. When this 
is done, the commodity or service will acquire a scarcity 



374 ECONOMICS chap. 

value ; the capital and labour employed in supplying it 
will have produced an amount of value greater than that 
produced by the same amount of capital and labour em- 
ployed in a market where suppliers compete and do not 
limit supply. Now " rent," Eicardo says, " is always the 
difierence between the produce obtained by the employ- 
ment of two equal quantities of capital and labour." 
Scarcity and monopoly values of all sorts, then, are akin to 
Ricardian rent. The motive of artificial limitations of 
the supply of anything is to secure on the capital and 
labour supplying it a higher return than could be obtained 
if the supply were not so limited. The test of Ricardian 
rent can be applied to scarcity and monopoly incomes ; 
the output of the capital and labour employed in one of 
these monopolies is not proportionate to the payment for 
the product and will not be checked if the price falls ; it 
may even be increased, since at lower prices a larger output 
will be needed to secure the same total profit. A large 
part of profits, therefore, are similar in their nature to rent ; 
for, as we saw in Chapter XVIII., in modern business 
restrictions on competition play an important part in the 
creation of profits. 

Ill 

Social Implications of the Ricardian Theory of Rent 

The social importance of the Ricardian Theory of Rent 
should by this time be clear. It points us to a distinction 
in income between those elements which evoke and stimulate 
production and those which do not. The owners of the 
agents of production can get for the use of those agents 
payment in proportion to their productivity, and their 
productivity is all that concerns the entrepreneur who uses 



XX RENT 375 

them. Society is concerned with the further question^ 
how much of these payments affects productivity — to what 
extent is the output of the agents of production unaffected 
by the amount of payment ? Ricardo showed that the 
productivity of land was largely independent of the pay- 
ment made for land ; we have seen that to a slighter degree 
the productivity of labour and capital is independent of 
payment ; to use Dr. Marshall's phrase^ wages and profits 
as well as rent contain elements which are not part of 
" the necessary supply price " of labour and capital, that 
is to say, are not payments that society must keep up if 
it is not to check production. The distinction is of the 
utmost importance in framing a general social policy. The 
policy of laissez-faire and the rigid maintenance of the 
so-called " Rights of Property " were based on the view 
that all payments evoked a response in production, and 
that competition kept the payment of every agent and 
every individual that contributed to production somewhere 
near subsistence level. The Ricardian analysis of distribu- 
tion indicates how large is the proportion of the flow of 
wealth which could be diverted from its present recipients 
without at all affecting the volume of the flow of wealth. 
The distinction he points us to, between income that does 
and income that does not evoke production, must be a 
deciding consideration in any judgment on the economy of 
the present economic organisation as a whole. 

A practical use of the distinction can be made in taxation. 
Taxes may be regarded as the price paid for the services of 
the State ; they cannot, however, be charged to individual 
citizens in proportion to benefits received ; the State there- 
fore levies payment on the whole community, on principles 
of practical convenience rather than of abstract justice. 
It is suggested that taxes should be concentrated on rent 



376 ECONOMICS chap. 

and the other elements of income similar to rent ; the 
argument for this is that rents are payments for productive 
power which is not due to the efforts or sacrifices of the 
rent receiver, and which will not be affected by a reduction 
in the payment. The followers of Henry George go further 
and advocate a single tax on the rent of land, on the ground 
that rents, not being the creation of any individual, should 
not be the property of any individual, but of the State. 

In its extreme form there are grave objections to this 
proposal. Though no individual may have created the rent- 
producing capacity of land by his labour, a great many 
individuals have jpaid for that capacity with the produce of 
their labour. Society has allowed rents to be treated as an 
ordinary investment ; the State has given no warning that 
it regards the investment of £100 in land as in any way 
different from the investment of £100 in Consols or Eailway 
Debentures, and to subject a man's income to a special tax, 
merely because he put his money into land instead of into 
Consols or Railway Debentures, may be expedient and may 
even be necessary, but has no basis in justice. Further, 
rents are capitalised every time the property that yields 
them changes hands, and the present receivers of rents are 
frequently receiving only the current average rate of interest 
on their investment ; as we have seen all along, from the 
point of view of the individual investor there is no dis- 
tinction between lent, wages, and interest. Moreover, 
the rent of land, as the term is used in ordinary speech, is 
not all " economic rent " ; a large part of it is interest 
on capital embodied in permanent improvements of the 
land, and in practice it is extremely difficult, sometimes im- 
possible, to distinguish between the two sources of a given 
income. Economic rent, again, is not confined to incomes 
from land ; wages, fees and salaries, to some extent, and 



XX RENT 377 

profits to a very large extent^ include elements indis- 
tinguishable in principle from Ricardo's rent. Finally, 
if taxes are tlie price paid for the State's services, it is 
doubtful whether it is wise to exempt from all payment any 
citizen who benefits by those services, as would be done if 
Henry George's proposals were adopted ; taxes are the 
chief source of an interest in politics and the chief stimulus 
to a sense of political responsibility. 

In spite of these difficulties in its application, the dis- 
tinction between economic rent and other kinds of in- 
come is of importance to finance ministers. It must always 
be a principal aim of sound taxation to raise the money 
needed without checking the production of wealth, and this 
aim can be attained only by concentrating new taxation 
on the rent elements of private income ; these elements 
are payments for productive powers which are not evoked 
by payment, and which therefore will not be checked by 
taxation ; the other elements are evoked by payment and 
will be checked by taxation. The least amount of inter- 
ference with legitimate expectations is involved by appro- 
priating rents in capitalised form by a tax on unearned 
increments and taxes on inheritance. Land is not the only 
form of property subject to unearned increment, just as 
land-rent is not the only form of income that contains an 
element of economic rent ; but, unfortunately for the 
owners of the land of a country at the time when the 
taxation of unearned increment is first introduced, land is 
the form of property on which unearned increment can be 
most easily detected, measured, and taxed. The profits of 
speculation on the Stock Exchange are just as much unearned 
as the increment in the value of urban building sites ; unlike 
the profits of speculation on produce markets, they repre- 
sent no service to society ; and in amount, they must be as 



378 ECONOMICS chap, xx 

great as the unearned increment on land ; but they are not 
so easy to " get at " as the unearned increment on land. As 
the requirements of the modern State grow then we may 
expect attempts to concentrate taxation more and more on 
economic rent of all forms, wherever it can be detected, 
and on the large incomes which, it may be presumed, 
contain the biggest element of economic rent. And the 
tendency is expedient, since it is the only way of raising 
additional taxation without checking the increase in wealth. 
If we take into consideration the existing inequalities of 
wealth, it has an additional justification, as tending in a 
slight degree to correct those inequalities ; the injustice 
of selecting one class of investments for heavier taxation 
than the rest may be added to the list of inconveniences 
which arise from the incessant conflict between the rights 
of private property and the interests of the community. 



CHAPTER XXI 



THE STATE AND THE ECONOMIC ORGANISATION 



Private Property and Freedom of Enterprise 

The economic organisation that we have been studying 
is distinct from the political organisation of society, and 
largely independent of it. Economic relations overstep 
political boundaries and have become world-wide, while 
States are relatively local ; commerce is cosmopolitan, 
while States are, roughly speaking, national. The economic 
organisation achieved this independence in spite of the 
efforts of States, which sought dm'ing the period of the 
Mercantile System to control the flow of trade and the 
distribution of labour and capital among different em- 
ployments. Adam Smith's Wealth of Nations showed 
that the State, at any rate in the United Kingdom, 
had failed in this endeavour. The law hampered, but 
did not direct industry and commerce ; the organisation 
of industry and exchange and the distribution of the pro- 
duct were settled by contracts between individuals, and 
controlled by forces other than the laws of Parliament and 
the executive powers of the Sovereign. To-day, as in Adam 
Smith's time, the State has only a subordinate influence 
over the organisation of production and the distribution 

379 



380 ECONOMICS chap. 

of wealth. The organisation is much the same in countries 
in which the form of State varies, and we have been able 
to study the economic organisation so far without taking 
account of the political organisation. While, however, 
economic and political organisations are distinct, there is 
nothing in the nature of either of them to prevent the State 
from undertaking economic operations. While economic 
organisation and political organisation are largely in- 
dependent of each other, the degree of their independence 
varies from time to time and from State to State, and is 
never complete ; the two react on each other, and wide 
differences of opinion exist as to the proper relation between 
them. It is necessary therefore to consider, however briefly, 
what are the relations between the State and the economic 
organisation to-day, and to examine the policy of which 
the existing arrangement is the expression. 

During the nineteenth century the view of the relation 
of the State to economic organisation that had most in- 
fluence was the view that they should be as distinct and 
independent as possible. The obsolete and hurtful character 
of the State-regulation existing at the beginning of the 
century discredited State -regulation as such ; Adam Smith 
had shown that the organisation of industry and commerce 
was a spontaneous thing, owing little or nothing to the 
direct action of the State, and that it had in it a sort of 
self-regulating principle, which made it unnecessary for the 
State to interfere in the public interest. This self -regulating 
principle is the action of competition. A belief in its 
beneficent effects ^ was the mainspring of the movement 
to " fi'ee " industry and commerce from all State " interfer- 

^ " All systems either of preference or restraint, therefore, being 
thus completely taken away, the obvious and simple system of natural 
liberty establishes itself of its own accord." — Wealth of NatioJis, 
Bk. IV. ch. ix. 



XXI STATE AND ECONOMIC ORGANISATION 381 

ence/' and is the ground of most opposition to State-regula- 
tion to-day. Although an elaborate system of laws and 
administrative machinery regulates industry to-day — the 
movement in the first half of the century for the abolition 
of the obsolete system of State-regulation having been 
succeeded in the second half by a movement to impose 
new regulations adapted to the new conditions of industry — 
society still relies on competition, rather than on direct 
State action, to secure harmony between private and public 
interests. The organisation of production is on the whole 
effected by free contracts between individuals, the dis- 
tribution of the product is left by the State to be determined 
by the bargaining of the individuals who directly or in- 
directly take part in production. 

The present social system in regard to economic activities 
is based on two institutions, property and freedom of enter- 
prise. By the institution of property (or private wealth) 
society allows a person the exclusive use and control, and even 
the disposition after death, of any wealth that person may 
acquire ; by freedom of enterprise society allows a person 
to seek wealth in any way that person chooses. There 
are limits both to the rights of property and to freedom 
of enterprise embodied in the law ; the more obvious forms 
of theft and violence are excluded from freedom of enter- 
prise, and taxation is an obvious encroachment on the 
exclusive control of wealth by individuals. Still, the portion 
of the economic field over which property rights and freedom 
of enterprise do not operate is small in comparison with the 
portion over which they do operate ; the presumption in 
the case of any form of wealth is always that some owner 
has the absolute control of it, the presumption in the case 
of any trade is always that any individual is fi'ee to enter it. 
The nature of these institutions is brought out by a com- 



382 ECONOMICS chap. 

parison with medieval society, in whicli the idea that any 
individual should have exclusive control of land or freedom 
to enter any trade or occupation he liked would have been 
thought ridiculous. Property, that is, the exclusive use 
of wealth, is the prize ofiered by society to induce individuals 
to compete in producing wealth ; freedom of enterprise is 
the device on which society relies to ensm-e that no one 
shall acquire wealth without competition. 

The economic organisation is built up by the free enter- 
prise of individuals seeking wealth. Each is free — so far 
as the State is concerned, and with certain exceptions to be 
mentioned later — to apply his labour or his land or his 
capital to any branch of production and in any way he 
thinks best ; each is left by society to get in return, by 
bargaining, without interference of the State, what share he 
can of the product. Economic relations depend, accord- 
ing to the theory of the present organisation, not on 
status but on contract. The State may lay down con- 
ditions, which must be complied with before it will enforce 
any contract, and some contracts, such as a gambling 
debt, it may refuse to enforce at all ; but it does not 
ordain what shall be produced or who shall produce, 
nor does it decide how the product shall be divided ; it 
does not as a rule fix prices or wages, the rate of interest 
or the amount of rent, and only in exceptional cases does 
it directly organise production. 

The indicator that production follows, the guide that 
tells individuals to what purposes to apply their labour 
or their capital or their land, is market value. Value, we 
have seen, depends on the relation of supply to demand. 
When the value of a thing goes up, it indicates either that 
the demand has increased, or that the supply has fallen off, 
and in either case that more is wanted ; the higher value 



XXI STATE AND ECONOMIC ORGANISATION 383 

ofiers to producers higher remuneration, and it is assumed 
that under a system of free enterprise individuals can be 
relied on to increase the supply. When the value of a thing 
falls, it indicates either that the demand has fallen oil or that 
the supply is in excess, in either case that less is wanted ; it 
is assumed that the fall in value will warn people to apply 
their productive powers to other objects and so check the 
supply. Society — since normally it makes no other pro- 
vision for directing its productive forces — assumes that 
value is an adequate indicator of wants, and that with this 
automatic indicator nothing further is required to secure 
the most economic application of productive forces to need. 
For regulation of production and distribution in the 
public interest, society relies on competition. We have 
already examined competition in Chapter VI. We saw 
there that it works in two directions. Trades, firms, and 
individuals compete to sell their product or the productive 
powers of their land, labour or capital ; they compete for 
custom, which means for a share of the wealth of society 
in exchange for What they have to offer. Similarly in- 
dividuals, firms and trades compete to buy ; they compete 
with one another in offering of their wealth for the finished 
or partly finished products of industry or the productive 
powers of land, labour and capital. The competition to 
sell tends to keep down prices, and also wages, interest and 
rent, which are the price paid for the services of labour, 
capital and land ; it tends to force prices down to cost 
of production, and this effect of competition is the chief 
influence on which society relies to protect the consumer 
against exploitation. The competition to buy tends to 
force prices and wages, interest and rent up ; and this 
effect of competition is the influence on which society relies 
to secure fair treatment of the producer and a just distribu- 



384 ECONOMICS chap. 

tion between different kinds of producers and between the 
different agents of production. If any trade or class of 
producers is getting more than it ought, the high value 
of its product is expected, under the system of free enter- 
prise, to attract competition, which will force it to accept 
less ; if any is getting less than it ought, the low value of its 
product is relied on to check production, divert labour and 
capital elsewhere, and so force up the value of the product 
and the remuneration derived from it. All are compelled 
by the fear that their competitors will undersell them con- 
stantly to adopt the latest methods and equipment. At 
the same time an incentive to make experiments and dis- 
cover improved methods exists in the higher margin of 
profits which the innovator draws in the interval between 
the first application of the new method, while prices are at 
their old level, and its general adoption, when the reduced 
cost of production all round brings prices down. In the 
long run, however, competition gives the benefit of improved 
methods to the consumer in the form of reduced prices ; and 
since competition to sell is usually stronger than competition 
to buy, the free play allowed by society to competition 
works on the whole in the interest of the public as con- 
sumers rather than as producers. Because society normally 
relies in this way on competition for regulation of production 
and distribution, the phrase " the present competitive 
system " is a just description of the present economic 
organisation. 

II 

Regulation and Supersession of Freedom of Enterprise 
by the State 

Experience, however, has shown that society cannot, 
without bad results, leave production and distribution 



XXI STATE AND ECONOMIC ORGANISATION 385 

entirely to the regulating influence of competition. There 
has been a steady growth of State-interference with industry 
ever since the doctrine of non-interference was first pro- 
mulgated. In the early factories competition^ coupled with 
the defenceless condition of the workers, tended to make 
the worst conditions of employment into the standard 
conditions. The abandonment of sanitary conditions, hours 
of work, speed of work, exposure to risk of accident from 
machinery and the age of the workers to the regulation of 
competition, made hells of mines and factories, and com- 
pelled the State to interfere in defiance of any economic 
principles ; conditions in domestic workshops were probably 
just as bad, but the evils were not so obvious and the Govern- 
ment of the United Kingdom dealt with social evils not 
when they became acute, but only when they achieved 
notoriety. Hence arose Factory Legislation, " that first 
conscious and methodical reaction of society against the 
spontaneously developed form of the process of production," 
as Marx calls it. Conditions of employment are now 
regulated by the State in innumerable ways ; the contract 
of employment has become a " conditioned " contract, a 
contract, that is to say, which the State will not recognise 
and enforce, unless it complies with certain conditions 
laid down in statutes — as to sanitation, ventilation, fencing 
of machinery, hours of work, age of the workers, and 
in some cases medical inspection and even wages. This 
interference by the State does not supersede private 
enterprise, and does not abolish competition ; it merely 
places limits on the freedom of private enterprise and 
imposes some limiting conditions on competition. The 
difierence between the unregulated factory industry of 
the early nineteenth century and the regulated industry 
of to-day is the same as the difierence between a fight 

2c 



386 ECONOMICS chap. 

in the street and a fight in the ring under Queensberry 
rules. 

Just as the State has been forced to interfere with freedom 
of enterprise and regulate or supplement competition in 
the interest of producers, so it has been forced to interfere 
on behalf of consumers. Normally society leaves the 
quality of commodities to be maintained by competition, 
the theory being that consumers will exercise a sound judg- 
ment and purchase the products of those firms that give 
the best quality at a given price. In practice consumers do 
not always exercise this judgment ; they consider price 
rather than quality, often they have not the knowledge 
needed to judge quality, and the effect of competition is 
at least as often to beat quality down as to maintain it and 
reduce price. The State has therefore imposed a sort of 
minimum quality in the case of certain services. Freedom 
of enterprise in the medical and legal professions is restricted, 
and those only are allowed to practise who have satisfied 
the conditions as to training, etc., laid down by the pro- 
fessional associations to whom the State has entrusted this 
regulation. In adopting this method of securing the 
regulation of the professions and the quality of the services, 
the modern state is imitating the medieval municipality, 
which used the same device with the same object, by en- 
trusting the regulation of the crafts to privileged guilds. 
In the case of the chief articles of food the State has regulated 
their sale by Adulteration Acts, and inspects them to see 
that they are fit for consumption and that they are what 
they profess to be. The inspection of weights and measures 
is a similar " interference " to protect the consumer. The 
restriction of the sale of alcoholic drinks to individuals 
specially licensed has a slightly different motive ; it is not 
intended to secure the quality of the drink, so much as to 



XXI STATE AND ECONOMIC ORGANISATION 387 

ensure the cliaracter of tlie vendor ; hencC; doubtless^ the 
care with which the Justices of the Peace scrutinise the 
qualifications of all applicants for licenses. 

The interferences with freedom of enterprise which we 
have examined so far have been based partly on economic 
grounds, partly on grounds of morality or general social 
advantage. The wholesale interference which Protection, 
using the word in its special sense as the opposite of Free 
Trade, involves is justified partly on economic and partly 
on political grounds. Statesmen have felt dissatisfied with 
the cosmopolitan tendencies of commerce, and have sought 
to make commerce national by protective tariffs ; in the 
United Kingdom, where such a tariff does not exist, the 
movement to create one derives a large part of its force from 
the desire to make the economic organisation of society in 
the British Empire correspond with and support its political 
organisation. The more usual ground of protection is, 
however, not political, but economic ; it consists in a dis- 
belief in the necessary identity of private and public interests 
in economic matters, and a belief in the necessity of positive 
control by the State, instead of the automatic control afforded 
by competition. 

There are, however, an increasing number of cases in 
which the State has found itself forced to depart from its 
usual rule and to supersede private enterprise altogether. 
One case is monopoly. There are certain industries, which 
we examined in Chapter VIL, in which efficiency can be 
secured only by monopoly. In such cases the State cannot 
rely on competition to regulate private enterprise, since 
competition is technically undesirable if not impossible. 
Either, therefore, the State has to devise very stringent con- 
trol of private enterprise, or to supersede private enterprise 
altogether ; the tendency, as we saw, is for the State to 



388 - ECONOMICS chap. 

supersede private enterprise^ since only in that way can 
it be sure of complete control. Public utility services, 
railways, and postal and telegraph organisations between 
them represent a considerable proportion of the world's 
productive capacity ; they all tend to be taken over and 
worked by the State instead of being left to private enter- 
prise. If the tendency of the State, national and local, to 
become a large land-owner for similar reasons, be taken into 
account also, it will be seen that the exceptions to private 
enterprise are becoming almost as important as the rule. 
And this revolution is being achieved, not by any abrogation 
of the rights of property, but simply by the State acquiring 
this property by the ordinary method of purchase, usually 
with the proceeds of a loan. The State is a legal person, 
just like any individual or corporation, and can acquire 
property and exercise enterprise just like any other legal 
person. Although the State has taken over only technical 
or natural monopolies, the Trusts have given the State an 
important object lesson in the waste of divided control 
in competitive industry, and the economy of centralised 
control. 

A second case in which private enterprise has been 
superseded by State enterprise is the case of certain services, 
now among the ordinary functions of government but 
formerly left to private enterprise, of which education will 
serve as the type. Within the last two generations the 
State has made itself responsible for most kinds of education. 
It was forced to take this step, because education, though 
socially desirable, is not a thing that people are very willing 
to pay for. Even the Public Schools, the schools of the 
rich, cannot always pay their way, and have to appeal to 
the charitable public, like any vicar of a slum parish, for 
aid in the form of endowments. If every one received no 



XXI STATE AND ECONOMIC ORGANISATION 389 

more education than he or his parents were willing to pay 
for in an unsubsidised market, few would learn more than 
the three R's. Education is a service which will not be 
forthcoming in the quantity and quality that are socially 
desirable, if society relies on the system of free enterprise 
regulated by competition. Sanitation and highways have 
similarly been taken over by the State from private enter- 
prise. The care of sickness is on the border-line, the State 
having made itself responsible for the treatment of infectious 
diseases, while it leaves others, except for Insurance Act 
subsidies, to be dealt with by private enterprise and charity. 
Charity, or " voluntary effort," is a sort of compromise 
between private enterprise and State-action. When a want 
of obvious social importance is left unsatisfied by private 
enterprise — because the people who suffer the want cannot 
afEord to pay for the satisfaction of it — charity will step in 
and mitigate the unwillingness of the State to secure the 
social well-being. Such voluntary organisation is a departure 
from the principles of the " competitive system," just as 
much as is State-action ; considerations of expediency and 
convenience rather than considerations of principle determine 
whether a community shall act in these cases through 
voluntary organisations or through the State. A complete 
list of the services, which it does not pay private enterprise 
to offer and which have therefore to be provided either by 
charitable gifts or by the State, would be a long one and 
would include some of the most important of services. 
Education, as we have seen, belongs to this class. So does 
research. Universities would be in a poor way if they had 
to depend on the payment made for their services by those 
students who hold no scholarship or other subsidy. The 
Churches would not be much better off ; the Free Churches 
may be regarded in their economic aspect as co-operative 



390 ECONOMICS cHAr. 

societies, but tlie Established Churcli is dependent on 
endowments. Art does struggle along, tbanks to the social 
convention that requires the very rich to exhibit a portion 
of their riches on their walls ; but artists have terrible 
competition to face in the pictures of their dead predecessors, 
the Old Masters, especially in America. Left to the ordinary 
laws of supply and demand, the cult of beauty, the pursuit 
of knowledge and the service of religion — perhaps one 
should say religious organisations — would all languish. 

Ill 

Taxation 

Finally there are those services, the ordinary functions 
of government, that have never been left to private enter- 
prise. The State exists because individuals living together 
in a society want services which can be provided only by the 
organisation we call the State. They want laws to delimit 
their rights and a sovereign to enforce those laws, to maintain 
order, and to defend the State against attack from outside. 
Existing for these fundamental purposes, the State proves 
to be the most convenient organisation for supplying many 
other services, so that it is impossible to set any hard and 
fast limit to the functions of the State. Now the services 
of the State, whatever they may be, cost something to 
provide, and have to be paid for ; taxes are the price we pay 
for the services of government. Government services 
diSer from other services, first because they cannot as a 
rule be measured and allocated to individuals ; secondly, 
because we are compelled to accept them whatever the 
charge made. Hence governments cannot as a rule charge 
individuals prices or fees proportioned to the benefit con- 
ferred, and they are not subject to the check on incom- 



XXI STATE AND ECONOMIC OKGANISATION 391 

petence and extravagance that attends private enterprise 
in loss of custom and eventual bankruptcy ; the individual 
(if he is wise) decides what he will spend by the amount of 
his income, governments decide what they will spend first, 
and then fix their income to suit. To deal with the second 
difficulty and provide a check on extravagance, repre- 
sentative control of public finance has been devised ; to 
deal with the first and secure a just allocation of the charges 
of government, principles of taxation are needed. 

Principles of taxation have been classified under two 
heads. Administrative Precepts and Political Princi'ples. 
Under the first head come certain requirements of Govern- 
ment. Government requires a tax-system first of all to 
be productive ; hence a Chancellor of the Exchequer will 
be very reluctant to relinquish on any grounds of political 
principle a tax to which people have become accustomed 
and which brings in a large income to the Treasury ; and, 
on the other hand, he will be willing to forgo small receipts 
that take a great deal of collecting. Secondly, it requires 
a tax-system to b6 certain ; the yield must be easily calcu- 
lated and the incidence certain and reliable, or the intentions 
of the Government will be frustrated. Thirdly, it requires 
a tax-system to be elastic ; the system should contain some 
taxes, the rate of which can be readily varied to meet sudden 
and exceptional demands for Government expenditure. 
Under the same head of administrative precepts come 
certain requirements of the tax-payer. The first is again 
certainty ; the payer should know exactly how much, when, 
and where he will have to pay. Uncertainty is a check 
upon industry, and it makes the burden of taxation more 
grievous, since an unexpected burden cannot be anticipated 
and provided against like a certain one. Secondly, the payer 
requires a tax to be economical ; i.e. it should take from the 



392 ECONOMICS chap. 

tax-payer's pocket as little as possible over and above what 
it brings into the treasury. Protective duties are un- 
economical^ since the consumer has to pay an enhanced 
price, not only on imported articles which are taxed, but 
also on home-manufactured articles which are not taxed. 
Thirdly, the payer requires convenience in a tax ; a tax 
should be levied at the time and in the manner most con- 
venient to the payer. The advantage of the system of 
raising revenue by indirect taxes on luxuries is that it leaves 
the payer free to some extent to choose the time and amount 
of taxation he will pay. Of these administrative precepts 
certainty is the most important. Society can adjust itself 
to almost any burden if the burden is definite ; any un- 
certainty prevents this process of adjustment. Hence the 
saying, " An old tax is no tax/' and hence the known reluct- 
ance of finance-ministers to remit an old tax, however 
logical such action might seem. 

Of the political principles, on which a tax system should 
be based, the most important is the principle of justice or 
equality. Unfortunately it is not agreed in what justice 
or equality consists. One interpretation that suggests 
itself is taxation according to benefit ; but the benefit that 
accrues to any individual from the State cannot be measured. 
Another is that taxation should be proportional to income ; 
this was suggested by Adam Smith, who said, " The subjects 
of every State ought to contribute towards the support 
of the Government as nearly as possible in proportion to 
their respective abilities, i.e. in proportion to the revenue 
which they enjoy under the protection of the State." 
Ability to pay, however, is not, as Adam Smith assumed, 
proportional to income. Taxation proportional to income 
would mean inequality of sacrifice, since, in accordance 
with the principle of diminishing utility, a tenth part of 



XXI STATE AND ECONOMIC ORGANISATION 393 

a small income represents a much greater satisfaction than 
a tenth part of a large income. Hence 'progressive taxation 
is proposed ; a tax system which takes an increasing propor- 
tion of income as the income gets larger would secure some- 
thing like equality of sacrifice. Another interpretation 
of justice in taxation is, faculty, or ability to pay^ a com- 
promise between proportional and progressive taxation ; 
so far as there is any principle in existing tax systems, it 
is probably the principle of " faculty." 

Whatever interpretation be put on the principle of 
justice in taxation, it would probably be regarded as im- 
practical and visionary to base a tax system exclusively 
upon that principle. Hence finance ministers are urged 
to have regard also to the effect of the tax system on the 
flow of wealth. The ultimate source of all revenue is the 
national income, and from the purely economic standpoint 
a tax system should be so devised as not to reduce the 
national income or check its growth ; taxes should be levied 
where they will not reduce efficiency. This end can be 
achieved by taxing 'rents, and we have already discussed 
the principle in Chapter XIX. These " principles of taxa- 
tion " are indefinite and often conflicting. The best 
tax system must be a compromise between them ; existing 
tax systems are based on no principle, and can be under- 
stood only by reference to the historical circumstances under 
which they grew up. 

To sum up : society has departed very widely from the 
strict rule of non-interference with industry by the State ; 
indeed, the policy of non-interference was never carried 
out logically by any State, and in the United Kingdom the 
beginnings of Factory Legislation, the type of the new 
State interference, were established in the practice of the 
State before the Corn Laws, the type of the old interference. 



394 . ECONOMICS chap, sxi 

were repealed. While, however, State interference is general, 
the direct supersession of private enterprise by State action 
is still the exception. If we ask for a brief description of the 
present social system in its economic aspect, " competitive " 
is still the best we can find ; if we look for a rule or principle 
on which the system is founded, we find it still in the separa- 
tion of economic organisation from political organisation. 
As a rule and in the main, society still relies for the organisa- 
tion of its economic activities on private enterprise, with 
private property for incentive and competition as regulator. 



CHAPTEE XXII 

THE STATE AND THE ECONOMIC ORGANISATION 

{continued) 



The Assumptions of the Present Stjstem 

The attitude of society to the economic organisation, 
which we studied in the last chapter, is subjected to a large 
amount of criticism. This criticism is usually combined 
with and dependent on the propaganda of some alternative 
system or poli'cy, and as such falls outside the scope of this 
book, which has for its object merely the elucidation of the 
present system and not the advocacy of some alternative 
system. The present system, however, although it is the 
outcome less of the application of principles to the problem 
of social control over the economic organisation than of 
the general neglect of the problem by statesmen, makes 
certain general assumptions, on which it depends for 
justification ; and it falls within the scope of our scheme 
to bring these assumptions into the light and examine them. 
These assumptions seem to be four in number. 

The first is that individuals in their economic relations 
can be relied on to pursue their own interest, and that their 
action will be rational and informed. It is only on that 
assumption that consumers can be expected to seek out and 

395 



396 ECONOMICS chap. 

give their custom to the producers who can satisfy them 
best, to play ofi competing producers against one another 
and so keep prices down towards cost of production ; it 
is only on that assumption that producers can be expected 
to bargain and secure the full value of their services. 

The second is that competition in industry will result 
in the survival of the socially fittest. No one denies that 
competition produces hardships for individuals ; such 
hardship is justified only if competition secures for society 
the elimination from industry of incompetent or dishonest 
entrepreneurs and the survival of the fittest. 

The third assumption is the most important and may be 
put thus : that as a rule private wealth or property will 
be acquired only by service and, conversely, that services 
will be induced by the possibiHty of acquiring private 
wealth, so that it will be the private interest of some one 
to supply every service in which there is a public interest. 
Only on this assumption is society justified in leaving the 
distribution of wealth, a social product, to be settled by 
private contracts between individuals ; only on this assump- 
tion is society right to restrict the activities of the State, 
and to lay the onus prohandi on the advocates, instead 
of on the opponents, of any extension of the State's 
activities. 

The fourth assumption is that market values correspond 
roughly with social values, and are an adequate indicator 
of need for production to follow. We must conclude that 
value is regarded as an adequate indicator of need, since 
the greater part of production is left to follow that indicator; 
if the value of a thing goes up, more labour capital and land 
will be applied to producing it, if its value goes down, less 
will usually be produced. 

Like most of the principles on which statesmen act (or 



xxn STATE AND ECONOMIC ORGANISATION 397 

more usually refuse to take action), and citizens vote, these 
assumptions are largely unconscious and seldom formulated. 

II 

TJie Assumption of Rational Self-interest 

That the first assumption, if true at all, is subject to 
exceptions, has been recognised by society. Adulteration 
Acts have been passed, because purchasers do not always 
scrutinise carefully the goods they purchase, and Acts to 
compel the fencing of machinery have been found necessary, 
because workers are sometimes so irrational as to take un- 
necessary risks. The exceptions, however, are much wider 
than the State has recognised, and the principles on which 
existing restrictions on freedom of enterprise have been 
based would justify much more extensive restrictions. 

If purchasers were always rational in their actions, pro- 
ducers would be able to secure their custom only by ofiering 
a better article at the same price as their competitors, or 
by ofiering the same article at a lower price. In practice 
these are not the only methods adopted to secure custom. 
Consumers are open to be infiuenced, their action is not 
always rational, and it is not at all unusual for a firm to 
spend as much in selling its product as in making it. The 
expenditure on advertising in the United States was esti- 
mated a few years ago at £120,000,000 a year. The object 
of it is to induce consumers to purchase commodities, which, 
if left to themselves, they would not purchase. Advertising 
is only one method of inducing purchasers to buy, when 
on purely rational grounds they would not buy ; the employ- 
ment of travellers, expenditure on surface finish and fancy 
wrappings, the constant introduction of novelties that have 
absolutely nothing but their novelty to recommend them, 



398 ECONOMICS chap. 

are all examples of the great waste of productive capacity 
which the irrationality of purchasers invites. Competition 
constantly tends to increase it, since if one firm in a trade 
adopts an advertising device all competing firms must follow 
suit ; the result is that all draw level again in competing 
power, while so much effort that might have gone to reduce 
cost of production and prices is wasted, so far as the con- 
sumer is concerned. The inertia which leads people to 
buy from the nearest shop, or from the shop they have 
always bought from ; the feeling of friendship which leads 
firms and individuals to maintain economic relations, even 
when more advantageous terms might be obtained else- 
where ; the ignorance that makes consumers eager to 
purchase anything for which a fashion can be created ; 
all these go to show that the self-interest of consumers is 
as little to be relied on as their reason. At the most, we 
can only say that competition among sellers will tend to 
protect consumers against exploitation ; custom, ignorance, 
and the persuasive arts of salesman and advertiser will often 
prevent the tendency from becoming a fact. Competition 
will tend to work in the consumer's interest, but producers 
spend large sums in getting control of the consumer. 

Even less true is it to assume that producers will 
be actuated in economic affairs exclusively by motives of 
material self-interest. The use of land and the expenditure 
of capital on land in England have for two centuries at 
least been influenced by political and social, as well as by 
economic considerations ; good agricultural land has been 
turned into parks, and landlords have made it a practice 
to remit in bad seasons a portion of the rent due to them. 
Investors in investing their capital are not uninfluenced 
by fashion, sldlful advertisement, philanthropy (as in the 
case of " disinterested management " public-houses), and 



XXII STATE AND ECONOMIC OEGANISATION 399 

even patriotism. Business men are influenced by friendship 
and their conception of what is " fair " in business. Least 
of all, workmen act from a reasoned consideration of their 
material interests. Their choice of occupation is largely 
a matter of chance — the State is only now attempting to 
devise machinery to ensure a wise choice of employment by 
the young. They rarely press for the most they could get 
when trade is booming ; strikes would be many times as 
frequent as they are if the manual working class made it 
the chief object of their life to get as much as they could out 
of industry. 

This first assumption of the "competitive system" takes 
an unduly narrow view of human nature. The pressure of 
competition would be intolerable if every one in his economic 
relations always insisted on his full pound of flesh. So far 
as individuals are actuated solely by motives of material 
self-interest, industry does tend to become intolerable, as it 
is in the underpaid sweated industries of East London and 
the overpaid sweated industries of Pittsburg. Fortunately, 
human beings as a' rule remain human in their economic 
relations ; they are influenced by other than commercial 
motives. By relying on material self-interest for the driving 
force of industry, however, society encourages a wild pursuit 
of wealth ; it penalises the man (or class) that does not care 
about money-getting, and it tends to put wealth under the 
control of the greedy and unscrupulous. 

Ill 

The Assumption that Competition leads to the Survival 
of the Fittest 

How far can the second assumption be granted ? How 
far is competition in industry a struggle leading to the 



400 ECONOMICS chap. 

survival of tlie fittest ? It is often regarded as such. 
People with wealth complacently regard, themselves as on 
that account " fitter " than the poor, and therefore entitled 
to their greater riches ; possession of riches they take as 
both evidence and reward of " fitness." 

It is clear that the struggle can have the efiect of select- 
ing the fittest only if the competitors start level. The com- 
petitive system, in relying on competition to secure a just 
distribution of wealth, treats /ree competition as equivalent 
to equal competition ; private property makes it impossible 
that free competition should be equal. Most of the com- 
petitors are handicapped by lack of property, which means 
defective training and lack of capital. Hence for most 
people freedom of enterprise is an empty privilege ; they 
may be " free " to enter any trade or profession that ofiers 
a high remuneration, but they have not the means. On 
the other hand, the few who have property receive a start 
in the race, and can choose and continue in an occupation, 
irrespective of their ability, so long as their property lasts 
out. An increasing number of people are exempt by the 
accident of birth from the struggle for survival, and it is 
very largely from their ranks that the individuals are drawn 
who control industry and govern the country. Freedom of 
enterprise is often confused with equality of opportunity. 
Freedom of enterprise obtains ; but it is inefiective either 
to secure in every case the fittest for positions of direction 
and influence, or to eliminate the unfit from such positions, 
because equality of opportunity does not exist. Freedom 
of enterprise is a partial check on incompetence or " un- 
fitness," and it enables the exceptionally able or industrious 
or fortunate to rise to positions of importance, as the exist- 
ence of the " self-made man " shows. Its establishment 
has resulted in a great increase in wealth, testifying to a 



xxn STATE AND ECONOMIC ORGANISATION 401 

great improvement in the organisation of production ; 
but it cannot be relied on, in the existing inequality of 
opportunity, to secure a distribution of the product in 
proportion to ability and industry. While there is too 
much competition in some quarters, there is not enough in 
others. 

Assuming, however, that economic competition is a 
struggle tending to the survival of the " fittest," the question 
arises, " Fittest for what ? " So far as the test afforded 
by the struggle is effective, it is a test only of fitness to make 
wealth. The argument is a justification of free com- 
petition, only if the end of man is the production of material 
wealth. The distinctive feature of man is that he is a 
moral being ; he can choose his end, and judge his " fitness " 
by reference to that end. To justify free competition on 
the ground that it gives position and influence to the 
" fittest " is therefore to choose the production of material 
wealth as the chief end of man. If any other end be chosen, 
for instance art, the^ religious life or the service of others, 
then free competition will stand condemned, because the 
survivors of the economic struggle are not conspicuous for 
love of beauty, piety, or disinterested philanthropy. A 
St. Francis or a Stevenson (not Stephenson) survives by 
reason of his very unfitness to make money ; the cathedrals 
of the thirteenth century are a great achievement just 
because their builders did not adopt the methods that 
bring wealth in a competitive society. " Efficiency " is 
often used in the same loose way as " fitness." Just as 
the rapid acquisition of wealth, if due to causes other than 
luck, prove fitness to acquire wealth, which may carry with 
it unfitness to do anything else (especially to spend it well), 
so a high degree of efficiency may denote a low grade of 
ability and character, if the work is mechanical and requires 

2d 



402 ECONOMICS chap. 

little initiative and originality. Stevenson's " efficiency " 
at writing did not enable him to earn enough to keep him- 
self until he was over thirty, while the " efficiency " that 
earns a popular novelist thousands a year will often fail to 
keep his writings alive ten years after he is dead. The 
type of " efficiency " or " fitness " that the competitive 
system tends to throw up is the " self-made man " or the 
American millionaire ; he is sometimes a very admirable 
person, but sometimes one is reminded of Sydney Smith's 
reply to a man's boast that he was " self-made " — " You take 
a great responsibiUty off the shoulders of the Almighty." 

IV 

The Assumption that Wealth will he associated with 
Social Service 

The third assumption is the most important ; it is the 
most general ground on which production is left to private 
enterprise and distribution to private contracts. The 
assumption is of course only that, as a rule, private wealth 
is the reward of service and that, as a rule, services will be 
induced by the prospect of private wealth. Exceptions 
to the rule are admitted by the practice of States, and we 
have already noted the chief of these exceptions ; what 
we have still to note is that the grounds on which these 
exceptions were made would justify other exceptions so 
numerous and important as to suggest doubts of the validity 
of the rule. If it be found that the system of free enter- 
prise admits in its normal working of private wealth without 
service, then the presumption against State interference 
with production and distribution breaks down. 

The chief case in which the State has superseded private 
enterprise on the ground that private enterprise would allow 



sxii STATE AND ECONOMIC ORGANISATION 403 

individuals to exact payment out of proportion to service, 
and so acquire private wealth without service, is the case 
of technical monopolies. When monopoly is required by 
technical considerations, as in the case of most public utili- 
ties, the consumer loses his usual protection against exploita- 
tion, namely competition, and the State has to devise other 
safeguards. Any restriction of competition, however, even 
if it fall far short of complete monopoly, deprives the con- 
sumer of his safeguard, competition ; and restrictions on 
competition are far more frequent than perfectly free com- 
petition. In allowing freedom of enterprise society assumes 
that it will always pay producers to supply society with what 
it wants in the largest quantity possible ; a very little 
experience of the efEects of competition teaches producers 
that it may pay them better to restrict competition and 
limit supply. By limiting supply they force values up, 
and high values on a limited output may pay them as well 
as a limited output at a low value. The interest of society 
lies in a large output and low values, the interest of pro- 
ducers lies in high values, and if they can secure high values 
by no other means they will contrive to limit output. 
There is therefore in the system of free enterprise, since 
free enterprise includes freedom to combine as well as 
freedom to compete, a principle encouraging producers to 
make a profit out of society's loss ; they can make society 
pay them more by the simple process of giving society less. 
Nor is it safe to assume that freedom of enterprise will 
ensure that producers will apply themselves to producing 
the things that people want. Consumers are open to 
influence ; on the whole they are not averse to being told 
what they want, so that they are saved the trouble of 
deciding for themselves. Hence it is possible for producers, 
by advertisement and other means, to control demand, 



404 ECONOMICS ceat. 

and make a profit by supplying what nobody, who stopped 
to tbink, would want. Thus pills that cost a farthing a 
box to make and can have no eSect on any disease except 
by way of faith-cure are sold at Is. l|d. a box ; and count- 
less products, made only to sell, earn for their manufacturers 
profits which represent no social service. Even when the 
advertised commodity is good of its kind, as are many 
proprietary foods, and the receipts of the businesses supply- 
ing them do not much more than cover expenses, the pay- 
ments made by society are out of all proportion to the 
service received by society ; for a large part of the expenses 
of the businesses consist of the expenses of advertisement 
and selling. All the cases we examined in which society 
assumed rational conduct and self-interest without justifica- 
tion are cases in which wealth will be obtained by some one 
without a corresponding service to society. 

When we examined the function of the dealer, we found 
that there were certain kinds of deahng, which we called 
" illegitimate speculation," which profited individuals at 
the expense of society. It is not necessary to recapitulate 
them ; here we need only note that they tell against the 
assumption that wealth is obtained by service, and in the 
aggregate they form an important part of modern business. 
In most modern communities, owing to the growth of popula- 
tion and the increase of wealth, one kind of transaction 
akin to dealing afiords especial opportunities of growing 
rich without performing any equivalent service to society. 
There are certain forms of wealth of which the supply is 
limited : Old Masters are the most obvious and land 
the most important example. As population grows and 
wealth increases, the demand for such things grows, and 
the fortunate possessors of them grow steadily richer with- 
out hfting a finger. The continued influence of the older 



xxu STATE AND ECONOMIC ORGANISATION 405 

aristocracy in the United Kingdom is due largely to this 
source of private wealth. It should be as difficult by sitting 
still to add a penny to one's income as it is by taking thought 
to add a cubit to one's stature. 

The older aristocracy suggests another and the most 
important method of acquiring wealth without rendering 
service, namely inheritance. It is no merit in a man to be 
born the son of a millionaire ; yet society rewards his 
judicious choice of parents more highly than it rewards 
the efforts of its greatest artists, philosophers, scientists, and 
inventors. The inheritance of wealth is as important a 
cause of inequalities of wealth as is free enterprise ; it has 
not the same grounds of social expedience. Even if private 
wealth is found to be the best incentive to wealth production, 
freedom of testamentary disposition seems an unnecessary 
extension of its rights. In this respect Feudalism, with its 
close association of duties with property and its resumption 
of possession by the King whenever the duties attaching 
to the property could not be performed by the tenant, afEords 
a suggestive comparison with the modern system. To be 
logical the advocates of free enterprise and competition 
should advocate the abolition of inheritance ; the results 
of such a poHcy would be interesting and very different from 
the present system. 

Of almost equal social importance with the cases of 
individuals obtaining wealth without rendering service are 
the cases in which wealth is indeed obtained in return for a 
service, but for a service that would have been forthcoming 
even if no payment has been made — the cases, that is to 
say, in which the payment is of the nature of economic rent. 
Land gives a service for which society pays the land- 
owner ; but land would be just as serviceable if no payment 
were made. We have seen that economic rent, or payments 



406 ECONOMICS chap. 

for productivity which is not evoked by or dependent on 
the payment, form a large part of income, not only of 
the income from land, but also, though in a less degree, 
of incomes from labour and capital. We saw also that 
society makes no distinction between economic rent and 
payments which do evoke, and are necessary to evoke, 
productivity ; and no distinction between investments in 
property that yields economic rent and investments in 
property that yields only interest. Any wholesale con- 
fiscation, therefore, of rents or rent-yielding property would 
disappoint the legitimate expectations of individuals ; 
it would involve injustice to these individuals and might 
create a feeling of insecurity that would outweigh the 
advantages of the confiscated property. While, however, 
the theory of rent does not justify a policy of confiscation, 
the consideration of economic rent remains of the utmost 
importance in forming a general view of the economic 
organisation, since it is essential to a sound judgment of 
its advantages. It is an obvious defect of the present 
arrangement that society pays so much of its wealth to 
individuals, not indeed for nothing, but for services which 
it might have had without paying for them, if only it had 
not allowed them to get into private hands. The present 
arrangement is socially wasteful, since society spends so 
much of its income in applying its normal incentive to 
production — property or private wealth — where no incentive 
is needed. A recognition of this waste is to be discerned 
in the attempt to concentrate the new taxation needed 
to finance new State-services on large incomes, of which 
economic rent may be presumed to form a large part, and 
to buy up natural monopolies and land, to secure any in- 
creases in the rent they yield. 

The assumption then that property represents service 



xxii STATE AND ECONOMIC ORGANISATION 407 

to society is too large to fit the facts, and the cases in wliich 
society has recognised an exception by socialising a service 
or taxing a form of income by no means exhaust the 
exceptions. Free enterprise must be the basis of any 
organisation of industry, but its disadvantages have been 
underrated, and there is no adequate ground for the existing 
presumption against State-enterprise. Even when wealth 
is obtained in return for service, the service may be accom- 
panied and neutralised by some disservice ; the cheap goods 
of the sweater are a service, but a service neutralised by 
the social evil of sweating. This aspect of the present 
economic organisation, however, can be considered better 
in a later chapter. 

Even less adequate does private enterprise appear when 
we consider the converse of the assumption we have been 
criticising, namely, that all the services society needs, and 
in the present state of wealth can afiord, will be forthcoming 
from private enterprise. So numerous, we have seen, are the 
cases in which the State supplies services, formerly neglected 
or supplied by private enterprise, that the assumption 
would need no further criticism if it were not that there 
exists a widespread though unconscious feeling that a 
service is not important or worth providing, unless it will 
" pay " in a competitive market. This simple test of the 
need for a thing. Will people pay for it ? is doubtless useful 
and convenient as a rough-and-ready guide to production ; 
more than that it is not. To use it as a general test of the 
value of services is to assume a coincidence of public and 
private interests which does not exist for two reasons : 
firstly, because many people are too poor to pay for things 
which it is in the pubUc interest that they should have, and 
secondly, because there are many services enjoyed com- 
munally, which individuals either will not or cannot pay 



408 ECONOMICS chap. 

for individually. In the fii'st class fall the elementary 
functions of government. The administration of justice 
was at one time supplied for fees and paid for by fees ; 
society found it " pay " better to supply it " at a loss." 
General elementary education is needed in the interests 
of society, but cannot be paid for by those who benefit 
by it. Sanitation and the treatment of infectious diseases 
the State has taken over from private enterprise ; for the 
same reason, namely, that health is a public interest, it is 
assuming responsibility for the treatment of other diseases 
and for the feeding of school children. Decent housing 
accommodation cannot be supplied commercially to certain 
classes ; and apparently land for small farmers is not to be 
had at a price they can pay ; in both cases the State is 
interfering. In the second class fall such amenities of town 
life as parks, picture-galleries, and museums. Individual 
workmen in congested districts cannot afiord open spaces, 
the town provides them ; individual students of art cannot 
afiord to buy good pictures, the State buys for them, — it 
is true that the taste shown by the State in its purchases is 
not always the best possible, but the taste of the State is 
the average of the taste of the citizens, and that can be 
raised only by a more generous expenditure on art. Liberal 
studies and research do not " pay " commercially ; the 
State therefore contributes to their upkeep, and ought to 
contribute more. Trams and hght railways may justly be 
run " at a loss," if they help to relieve overcrowding or 
are needed to maintain the prosperity of an agricultural 
district. Services supplied by the State " at a loss " are 
merely services paid for partially by taxes instead of by 
prices ; the maintenance of law and order and national 
defence are paid for wholly by taxes, yet no one speaks of 
them as being " run at a loss." Utility to a community 



xxii STATE AND ECONOMIC ORGANISATION 409 

is one thing, utility to individuals another. Where in- 
dividual values and social values coincide, the supply 
of services can be left to private enterprise ; where, as in 
so many cases, they do not coincide, the State, or some other 
public body, must act. In the case of government enter- 
prise a commercial loss may be a social gain. 



The Assumption that Market Value is a Satisfactory 
Indicator for Production to follow 

The last assumption of the present economic system is 
that market value is not only an automatic indicator for 
production to follow, but an ideal indicator, which we have 
only to follow to secure the greatest possible amount of 
satisfaction for society from the efEorts and sacrifices of 
production. A high value indicates that a thing is wanted 
much, it also stimulates the supply of it, falling value in- 
dicates that no more of ^a thing is wanted and at the same 
time checks the supply of it ; so that, it is assumed, we 
have only to leave business men to follow market values 
in their production and society will get just what it wants. 
According to this view, given free competition, supply and 
demand tend to reach an equilibrium, at which the eSorts 
and sacrifices which He behind supply are exactly balanced 
by the satisfactions which lie behind demand ; thus present 
values represent a maximum economy of the application of 
means to ends, a maximum of satisfactions and a minimum 
of cost. 

Such a conclusion requires not merely free but equal 
competition. The indicator value, though it is as a matter 
of fact followed by production, is very unreliable as a guide 
to the best use of the productive powers of society. Let 



410 ECONOMICS chae. 

us return for a moment to our examination of the influence 
of utility on value. We saw that the law of diminishing 
utility explains our valuations of things. The value we 
put on anything depends on the amount of it we have, 
every addition to our supply of it gives us less satisfaction 
than the previous addition ; therefore the falling of the 
value of a thing as the supply increases does indicate that 
it is satisfying a less intense want, and, by indicating to the 
producer that something else is now wanted, does conduce to 
a greater total of satisfaction. But this explanation tells 
us only why different quantities of the same commodity 
give different degrees of satisfaction to the same person ; 
why, in the instance we took, a third pound of tea a week 
gives less satisfaction than the first pound of tea ; it does 
not tell us why different individuals set different valuations 
on the same quantity of the same commodity, why, for 
instance the man with £1000 a year values one pound of tea 
at 5s. and a second at 3s., while the man with only £100 
values one pound of tea a week at 2s. and a second pound at 
Is. The reason is of course that their incomes are different. 
The actual valuation that a man sets on a pound of tea a 
week depends not only on the number of pounds he has 
already, but on the income out of which he has to satisfy 
all his wants. 

Suppose we had a " unit of satisfaction," suppose 
satisfactions could be measured and we could express any 
satisfaction in terms of that unit ; then we should find that 
a sovereign represented to the man with £10,000 a year 
the possibility of, say, one unit of satisfaction, to the man 
with £1000 a year something like ten units, and to the man 
with a wife and children to keep on a pound a week perhaps 
a hundred units of satisfaction. Spent by a rich man a 
sovereign gives one unit of satisfaction, spent by a poor man 



xxn STATE AND ECONOMIC ORGANISATION 411 

a sovereign gives a hundred times as much satisfaction ; 
therefore the rich man to get the satisfaction of a pound of 
tea a week might be willing to give ten sovereigns, while 
the poor man, for the same satisfaction, would only give a 
tenth of a sovereign. The rich man, since his chief wants 
are all near the point of satiety, will spend in satisfying his 
slightest whims as much money as the poor man will spend 
to satisfy his greatest needs. The reason is the same law 
of diminishing utility ; the rich man can carry the satisfac- 
tion of his wants further than the poor man, and therefore 
gains less from an additional purchase. 

Now in the market the rich man's sovereign, which 
represents one unit of satisfaction, has exactly the same 
influence as the poor man's sovereign, which represents a 
hundred units of satisfaction. If a rich man offers a 
hundred pounds for a Pekinese puppy while a poor man 
is offering ninety-nine pounds for the education of his 
children, the productive resources of society will be devoted 
to getting the rich man his Pekinese puppy before the educa- 
tion of the poor man's children will be thought of. This 
is so only if the proportion that costs of production bear 
to market value is roughly the same with the different 
services ; but as a matter of fact we may expect the margin 
of profit to be greater in the case of commodities consumed 
chiefly by the rich, since rich buyers have not the same 
incentive as poor buyers to beat prices down. The richer 
classes will have the first claim on the productive resources 
of society because money means least to them ; as their 
luxuries pall and their whims are exhausted, they will offer 
less and less for further satisfactions, the value of their 
luxuries will sink, until it pays producers better to satisfy 
the needs of the poor ; by following market values pro- 
ducers supply the extravagant futilities of Mayfair, while 



412 ECONOMICS chap. 

food, decent housing and clothing are lacking in the East 
End. 

In following market values then the organisers of pro- 
duction are following a blind guide, so far as the social 
value of work is concerned. Market values would indicate 
where the productive powers of society can be applied to 
produce the greatest satisfaction only if incomes were 
equal or proportionate to families. The unequal distribu- 
tion of wealth makes them a false and misleading indicator, 
and the greater the inequality of wealth the greater will be 
the waste due to this faulty application of the productive 
powers of society. Inequality of wealth is increasing, 
great fortunes are like snowballs ; we may expect therefore 
a less and less economical application of productive power 
to wants as time goes on, we have to look to a growing 
divergence between the aims of production and the needs 
of society. Society is behaving like a man who should 
spend £50 on a court dress when he has no underclothing, 
or buy fancy cakes when he needs bread. Market values 
are the outcome of the present distribution of wealth ; 
the principle on which they, and therefore the economic 
organisation of which they are the centre, are based is the 
principle " Unto him that hath shall be given, aud from 
him that hath not shall be taken away even that which 
he hath." 

This characteristic of market values makes the present 
distribution of income, as well as the direction of production, 
unreasonable. We saw that productivity was an important 
influence in distribution ; competition among entrepreneurs 
tended to secure for each producer and each agent of pro- 
duction the equivalent of its productivity. But " pro- 
ductivity " is always productivity of value, and therefore 
bears no necessary relation to need. The product of ]\iilton's 



xxn STATE AND ECONOMIC ORGANISATION 413 

labours from 1658 to 1665 was Paradise Lost, the productivity 
of those labours was between £10 and £20, the price he 
received for the product. The -produce of a farm is usually 
increased by keeping game down, but by stocking the farm 
with game at the expense of the produce the productivity 
will often be increased, since more will be paid altogether 
for the use of the land. The defence, then, of the present 
distribution of income that it is in accordance with pro- 
ductivity, that each gets the value of his contribution to wealth, 
is an explanation merely, not a defence. Value is a question- 
begging term. All that this argument amounts to is that 
the contribution of each is valued at what he gets. If we enquire. 
Have these values any basis in principle, any constant 
relation to social service, any absolute standard ? we find 
that they have not. 

In conclusion, it may be noted that the policy of laissez- 
faire, which dominated the State in English-speaking 
coimtries during a large part of the nineteenth century, 
created enormous difficulties for the State in the twentieth 
century. It was natural enough and doubtless expedient 
to sweep away a system of State-regulation of economic 
activities which had been rendered obsolete by the Industrial 
Revolution. But the evils of State-regulation in the early 
nineteenth century were due to the character of the regula- 
tion and of the State, not to State-regulation as such. And 
the State, having once relinquished the attempt to control 
the economic organisation, has found the task of control 
doubly difficult, since it has resumed the attempt. The 
very success of the policy of laissez-faire in stimulating the 
growth of material wealth has complicated the task, since 
it has created great fortunes and businesses, that can meet 
the State on terms of something like equality. Economic 
relations have in some places become of more importance 



414 ECONOMICS chap, xxn 

than political relations ; the economic organisation, which 
always develops more rapidly than the political organisation, 
threatens to swamp or control the State. Hence the strong 
reaction against laissez-faire ; hence the regulation of con- 
ditions and hours of employment, the proposal to return to 
Protection, the State fixing of wages, and, in some cases, of 
rates and prices, the proposal to extend to England from 
Scotland and Ireland the State fixing of rents, the munici- 
palisation of public utilities, the dissolution of trusts in 
America — though trusts are a perfectly natural outcome 
of free enterprise — the taxation of the over-rich. Yet the 
State has not got control of the economic organisation ; 
in many places the economic organisation controls the 
State ; and there are signs, in such movements as Syndical- 
ism, of a despair of the State as a means of securing the social 
control of the economic organisation, which will increase 
still further the difficulty of securing State control. More- 
over, the reluctance of nineteenth-century governments to 
regulate and supplement freedom of enterprise has resulted 
in evils that obscure the importance of freedom of enterprise 
itself. Freedom of enterprise in some form or another must 
be the basis of any organisation of production based on 
specialisation ; not only is it the only effective guarantee 
of individual initiative, and therefore of elasticity and 
adaptability in the organisation, but the alternative — that 
the State should decide in detail what every one shall do 
and what every one shall receive — is a task to which no 
body of officials is equal. But freedom of enterprise does 
not exclude State enterprise, and the existing presiwiption 
against any interference with freedom of enterprise is the 
most serious hindrance to true economic progress. 



CHAPTER XXIII 

WEALTH AND AVELFARE — THE MEASUREMENT OP WEALTH 

I 

Wealth as Product 

The word " wealth " is used in more senses than one. Tlie 
commonest seems to be " economic wealth," which, we have 
seen, means anything that satisfies a human want and is not 
unlimited in quantity. Economists take this meaning of 
the word and standardise it ; Economics is the study of the 
social organisation by which wealth in this sense is produced 
and distributed. The want which a thing must satisfy, to 
come under this definition of wealth, may be of any kind. 
The beer with which the drunkard tries to satisfy himself 
is just as much wealth as the beer that the temperate take 
to quench their thirst on a hot day. Rifles and bicycles, 
made sometimes by the same firms, are both wealth, though 
their uses are so different. " Bad " literature and " bad " 
art are wealth just as much as " good " literature and 
" good " art, since many people get a satisfaction from them; 
those who possess them are rich to the extent to which they 
possess them ; if they get no satisfaction from them them- 
selves, they can sell them to people who do, and with the 
proceeds buy something that they do want. While the 
want which a thing satisfies may be of any kind, the thing 

416 



416 ECONOMICS chap. 

must be limited in quantity, or it will not count as wealth. 
If it is unlimited in quantity the possessors of it will be 
imable to exchange it for anything else, since no one will 
give anything in exchange for a thing that can be had for 
nothing. This differentia is necessary to the definition of 
wealth, since the word is applied — strictly within its original 
meaning, but only metaphorically to-day — to things which 
satisfy human want and are unlimited in quantity. Fresh 
air, for example, and scenery are spoken of as wealth. In 
the ordinary sense of the word, however, they are not wealth ; 
no one who had more of them at his command than he 
wanted could get anything in exchange for them ; only 
when the supply of them is limited do they become wealth 
in the narrower and more usual sense of the word, as they 
would do if the fresh air were laid on to London by pipe 
from Margate, or the scenery enclosed in a park and a 
charge made for admission. 

This narrow use of the word wealth identifies wealth with 
the product of the economic organisation. The economic 
organisation as a whole exists to produce means of satisfying 
wants that are not unlimited in quantity or provided " free " 
by nature ; means of satisfaction, that is to say, which will 
not be forthcoming without some organisation to produce 
them. The organisation and its parts derive their value 
from the product ; the worker gets a wage only because his 
work is needed to produce these means of satisfaction ; a 
machine has a value only because it can be used for the 
same purpose ; the product is the end and object of the 
organisation. The wealth of an individual or a country 
is the means of satisfaction which he or it possesses, or, 
in other words, the amount of the product of industry and 
commerce which he or it can command. The product 
usually takes a material form — so many pieces of cloth, so 



xxm WEALTH AND WELFARE 417 

many tons of coal, etc. ; but it may equally well take the 
form of a service. Transport is an important part of the 
wealth of modern countries ; it satisfies wants, directly and 
indirectly, and it is not provided by nature free. The 
services of the professions are wealth of the same kind. 
Indeed, material goods are desired only for the services which 
they render ; men want not cloth but clothing, not coal 
but heat, and cloth and coal are wealth only because they 
enable men to satisfy these wants. But whether we speak 
of goods and services or of services alone as forming the 
content of wealth, we identify wealth with the product 
of the economic organisation ; the economic organisation 
exists to produce these means of satisfying wants, and but 
for the economic organisation they would not be forthcoming. 
The method by which wealth is measured brings out 
clearly this conception of it. It is always assumed that 
wealth is measurable, and it seems only a matter of time 
and trouble to total up the wealth of a country in tons of 
this commodity, yards of that and gallons of another. Such 
a method, however, would give us no measure of wealth in 
the form of services ; we might put in our inventory so 
many surgeons and so many teachers ; but since the surgeons 
and teachers might difier very much in their ability, skill 
and industry, we should have no measure of the country's 
means of satisfying its wants in the way of surgical treat- 
ment and education. And even in the case of material 
forms of wealth such a measure is inadequate, since it 
ignores difierences in quality ; sixty yards of one kind of 
cloth may be double the amount of wealth embodied in 
sixty yards of another kind of cloth. The difficulty is 
overcome by totalling not the forms of wealth themselves, 
but their exchange-values. Most production is carried on 
for exchange, and nearly all forms of wealth are at some 

2 E 



418 ECONOMICS chap. 

time or other exchanged. This exchange takes place not 
directly, but through the medium of money. Hence money 
becomes a general common measure of exchange- values, and 
a total of wealth is expressed in terms of money ; so ac- 
customed have we become to measuring wealth in money, 
that the word " money " is frequently used as synonymous 
with " wealth." 

There are, however, practical difficulties in the way of 
getting directly the total value of the product of the economic 
organisation, since in no country is anything like a complete 
annual census of production taken. Indirectly, however, the 
total can be reached by adding together incomes, which 
we have the means of estimating. A man's income is the 
claim (measured in money) which he has on the product of 
the economic organisation ; the total of the incomes of the 
people in the country will be the total value of the country's 
product, since the claims as a whole are exchanged for the 
product as a whole. We have more information about 
people's incomes than we have about their capital or total 
wealth, and, as we saw in Chapter XII., we must consider 
wealth as income rather than as stock, if we are not to 
overlook certain important forms of wealth, especially 
services rendered directly and not through the medium of 
commodities. 

By making a total of incomes the wealth of the United 
Kingdom is estimated (1913) at about two thousand million 
pounds a year. The information about incomes is obtained 
from various sources. The Income Tax returns bring imder 
review all incomes of more than £160 a year, and incidentally 
some incomes of less than that amoimt. Some corrections 
have to be made in the total of income given hy the Income 
Tax returns ; it is a total of gross incomes, and some deduc- 
tion has to be made for repairs and renewals ; on the other 



xxiii WEALTH AND WELFARE 419 

hand, some addition must be made for income escaping 
assessment owing to false and incomplete returns. To 
the incomes of the income-tax paying class is added an 
estimate of the total wages paid in the country, i.e. the 
incomes of the manual worker class. This is based on the 
Censuses of Wages taken in 1906 and 1886. The returns 
made by employers on those occasions were voluntary and 
therefore not comprehensive, but they were full enough to 
afford a basis for estimating the normal earnings of every 
class of worker ; the Census of Population gives the number 
of individuals in each class, and the Labour Department 
of the Board of Trade keeps a record of changes in wage- 
rates ; hence it is possible to estimate the total income of 
the wage-earning class. A more complicated task is the 
estimate of the total incomes of the class that falls between 
the income-tax paying class and the wage-earning class ; 
a reliable estimate, however, has been made by a committee 
of the Economic Section of the British Association. These 
three classes cover the whole population of income-receivers, 
and by adding together the estimates of their incomes the 
figure of two thousand million pounds is reached. This total 
of incomes is the total value of the annual product of the 
country's economic organisation ; for the incomes are simply 
the claims on the product which the economic organisation 
gives rise to. The method of measuring wealth, then, and 
the estimate of the wealth of the country as a whole, are 
based on the conception of wealth as consisting in product. 
There is no need to go behind this conception for the 
purpose of studying the organisation for producing and 
distributing wealth. Economics, in standardising this 
meaning of wealth, is merely following ordinary usage. A 
" rich " man is a man with a large command of the product 
of the economic organisation, whether he exercises it by 



420 ECONOMICS chap. 

buying goods or services. A " rich " country is a country 
which derives a large amount of product from its economic 
organisation, or has large claims on the product of other 
countries' economic organisation — as England has in the 
form of interest on foreign investments. The present age 
is " rich " compared with earlier ages, because the product 
of its economic organisation is so much greater ; when we 
speak of the " growth of wealth " we mean the increase 
of product. On this conception of wealth the present 
economic organisation is based. It is directed solely to 
securing the largest possible product in proportion to 
expenditure, and is judged accordingly. Distribution is 
based on the assumption that those who contribute to 
production can be relied on to insist on a proportionate 
share of the product ; they are " efficient " in proportion 
to their productivity, and the system is " fair " or " unfair " 
according as distribution is in proportion to productivity. 

II 

Wealth as Welfare 

But the word " wealth " is capable of another meaning. 
It is used to denote anything that contributes to human 
welfare. In this sense, wealth will not exclude any means 
of satisfying human wants merely because they are not 
limited in quantity ; in this sense, fresh air and scenery 
are an important part of wealth. On the other hand, it 
does discriminate between wants, and excludes from the 
category of wealth the means of satisfying some wants 
which do not contribute to welfare. What satisfactions we 
regard as contributing to welfare depends on our ethical 
views ; but even the Utilitarian, who regards satisfactions 
quantitatively only and makes pleasure the end of life, will 



xxm WEALTH AND WELFARE 421 

hold that welfare requires some wants to be left unsatisfied 
(those that " draw repenting after "), while others need 
cultivation. 

There is not the same agreement in the application 
of the word wealth in this second sense as in the other 
sense. It is applied to different things according as con- 
ceptions of welfare vary ; the drunkard will apply it to 
beer, his wife probably will not. And conceptions of 
welfare vary widely. The statesman who is anxious to 
pursue a " spirited " foreign policy regards armaments as 
wealth in this second sense of contributing to welfare, as 
well as in the other, more ordinary, sense ; the Quakers 
regard armaments as what Ruskin called " illth." Ruskin's 
quarrel with his contemporaries — or one of his quarrels — 
was that they regarded as contributing to welfare, and 
therefore as " wealth " in this deeper sense, the great mass 
of mechanically ornamented products of modern industry, 
which he regarded as ugly, useless and demoralising. The 
English governing class of a hundred years ago encouraged 
enclosures, partly because it was to their private interest 
so to do, but partly also because enclosures increased the 
product of the land, and they thought that an increase in 
product must necessarily bring an increase in welfare ; jn 
Germany the same change was effected under a different 
conception of social welfare, the peasants on the land being 
treated as of more importance than the product of the 
land. 

Because there are these divergent conceptions of welfare, 
varying with every variation in ethical, aesthetic and 
political views, economists have chosen to leave on one side 
the study of wealth in this second sense, and have confijied 
themselves to wealth in the commoner, agreed sense ; they 
have studied the organisation for satisfying wants, without 



422 ECONOMICS chap. 

considering distinctions in the kind of wants . Unfortunately , 
the two senses of the word are not kept distinct in ordinary 
speech. It is impossible in practice to prevent the associa- 
tions attached to wealth in its wider sense from attaching 
themselves to the word when it is used to mean only economic 
wealth. The distinction can be made and maintained in 
a systematic treatise ; but as soon as we pass from the 
treatise to conversation or public discussion, from study to 
practice, our careful distinction is likely to be ignored and 
perhaps forgotten by ourselves. It is impossible, therefore, 
to make any practical use of economic studies, to apply 
the conclusions of economic science, without considering 
what is the relation between wealth in the narrower sense 
of economic wealth and wealth in the wider sense which 
includes all means of welfare ; we must have a clear idea 
of the relation of wealth — for the rest of this chapter we will 
keep the word to mean economic wealth — to welfare. It is 
the more necessary to consider this question, since wealth can 
be measured and changes in its quantity stated definitely, 
while of welfare there is no exact or definite measure ; 
inevitably, in the absence of any other measure of welfare, 
the economic measure will be used, and an increase in wealth 
treated as an increase in welfare. To state fully the relation 
of wealth to welfare would, of course, involve answering the 
question. What is welfare ? and comparing and criticising 
all the divergent conceptions of welfare, which would be an 
ethical enquiry and beyond our scope. Our purpose, how- 
ever, will be served if we can indicate the chief influences 
on welfare which the measure of wealth ignores, and so 
make clear the limits within which an increase of wealth 
indicates an increase of welfare. That is the important 
practical question ; how far, and under what circum- 
stances, an increase of wealth is an increase of welfare. 



WEALTH AND WELFARE 423 



III 

Defects in the Usual Method of computing the Country's 
Wealth 

The wealth of the United Kingdom is estimated at about 
two thousand million pounds per annum. The method by 
which this estimate is reached has been described. Although 
the best available, it has serious defects ; it excludes much 
that is wealth and includes much that is not wealth. 

It excludes much that is wealth, because it takes account 
only of goods and services that come within the circle of ex- 
change . There are many services given for which no payment 
is made, but which are wealth just as much as services which 
are paid for. The most important of these unpaid services 
is the domestic work of wives and daughters. Domestic 
servants are paid wages, hence their services are included 
in the estimate of the country's wealth ; wives and daughters 
are paid nothing for exactly the same services, hence no 
record or measure of their work exists, and their services are 
ignored in estimating the country's wealth. The services 
of members of parliament (since 1911) are counted as part 
of the country's wealth, since they receive a salary which is 
assessed to Income Tax, and is therefore included in the 
two thousand million pounds at which the country's wealth 
is computed. The humbler, but more useful, county or 
borough councillor is paid nothing for his services ; there- 
fore he does not affect the total of income assessed to Income 
Tax or estimated as wages ; therefore his services are ignored 
in the process of computing the nation's wealth. The same 
is the case with all voluntary social and public service, it 
is ignored in the ordinary computation of wealth ; yet the 
economic loss of a war would hardly be greater than the 



424 ECONOMICS chap. 

cessation of such services. The method ignores material 
forms of wealth as well as services. A park occupied by its 
owner comits as wealth, since its annual value counts as 
part of its owner's income for purposes of income tax ; if 
he presents the park to the community, the service it gives 
will probably increase, but will no longer be included in 
the computation of the country's wealth, since it will no 
longer form a part of any person's money income. The 
vegetables a man buys are included in the two thousand 
million pounds ; the vegetables he grows for his own use 
will not be, since they do not come into the market, where 
wealth is measured by being exchanged for money. This 
element of subsistence economy is more important on the 
Continent than in the United Kingdom, and used to be more 
important than it is ; as it gives place to commercial 
economy, the amount of wealth measured will increase, but 
there may be no increase in the product of the country's 
activities and resources. Of course it would be possible 
to estimate the value of these uncommercial goods and 
services, and add it to the estimate of the country's wealth 
obtained by the other method ; but the calculation would 
be difficult, there are no materials for it in existence, it is 
not, as a matter of fact, made, and the wealth it represents, 
remaining unvalued, tends to be overlooked. 

On the other hand, the ordinary computation of a 
coimtry's wealth includes much that is not wealth. It 
includes every form of money income which is received by 
the individuals in the country ; there are, however, sources 
of income to individuals which are not wealth from the 
point of view of the community. The National Debt will 
serve as an example. Consols are property, not wealth. 
The interest on them is not in the same category as tlie 
interest paid on industrial investments or on loans made 



xxm WEALTH AND WELFARE 425 

to Municipal Corporations for industrial purposes ; the 
interest on the latter is produced by the plant in which 
the investment is embodied, it is an actual addition to 
wealth, which the investors are able to secure ; the interest 
on the former is merely a transfer of so much wealth from 
the tax-payer to the holder of Consols, since the loan which 
the Consols represent has been spent once for all on war 
long ago, and is doing nothing to increase production now. 
At least 1 per cent of the " wealth " of the United Kingdom 
is of this nominal character. 

More important than this source of error is the defect in 
the method of computing wealth, by which certain services 
are treated as additions to wealth which should really be 
treated as deductions from it. Coal is wealth, and the 
salaries, profits, and wages to which its production gives rise 
are rightly included in the estimate of the country's wealth. 
But the use of coal produces so much dirt in the atmosphere 
that clothes need washing more frequently than they would 
do but for its use. A large part, therefore, of the expense 
of laundry should be set against the use of coal. The 
services of the laundries are not an addition to the wealth 
of the country ; they are part of the cost of securing the 
addition to the wealth of the country made by the use of 
coal. We should deduct them from the value of the coal 
to get the net or real addition to the wealth of the country 
made by coal ; the ordinary computation adds them. There 
are many cases in which one industry or service is called for 
by the ill efiects of others, many cases in which one group 
of workers merely repairs evils incidental to the work of 
another set, with the result that the net addition made to 
wealth is far less than the apparent addition. 

The increase in wealth produced by the factory system 
is subject to large discounts on this account. By bringing 



426 ECONOMICS chap. 

together the workers in large masses, the system enormously 
increased the productivity of labour ; but by bringing them 
together it at the same time created the modern town. 
Life in a town, to be healthy and decent, requires a much 
greater expenditure per head of population, on sanitation, 
street - paving and cleansing, police, and even education, 
than life in the country, as is shown by the higher level 
of local taxation in town than country. To estimate the 
net addition made to wealth by modern methods of pro- 
duction, therefore, we must deduct from the value of the 
product the expense of all these public utility services ; 
they are all part of the social cost of production of 
goods made by these methods. The ordinary computa- 
tion of national wealth again does not deduct, but adds ; 
for it includes in the national income hoth the incomes 
derived from industry and the incomes derived from loans 
to establish these services and payments to maintain them. 
Factory inspection, wages boards, the trade union organ- 
isation which the workers have been forced to establish 
in self-defence, are all part of the social cost of production 
of goods made by modern methods, and should be debited 
against the goods. Similarly, if we wish to ascertain the 
real addition to wealth made by the motor industry, we 
shall have to deduct from the value of the motors the cost 
of reconstructing roads to suit motor traffic. Modern 
society is rather like an incompetent housewife, who " makes 
work " for herself by her slovenly methods ; with this 
difierence that she complains of the extra work, while we 
glory in it, boasting of the increase of wealth and the im- 
precedented dimensions of the national income. 

Another defect in the measurement of wealth arises from^ 
the fact that the only objective measure of wealth is market- 
value. Wealth is wealth because it satisfies human want ; 



xxm WEALTH AND WELFARE 427 

an increase of wealth should mean, therefore, an increase of 
satisfaction ; an increase of wealth as measured may take 
place without any increase in satisfaction. Our study of 
value has already revealed this to us. The value of a thing 
may change without any change in the thing itself. Restric- 
tion of supply or increase in demand will enhance the value 
of a thing without any increase in the satisfaction afforded, 
and demand depends on the distribution of purchasing 
power as well as on desire. The Degas, which the artist 
sold for £20 and an American millionaire subsequently 
bought for £17,000, had the same capacity to satisfy human 
want at the lower value as at the higher. The satisfaction 
which an opera singer's services give the nation will remain 
the same, whether he be paid £20,000 a year or a legal 
maximum of £500 a year ; but in the latter case the 
national wealth as measured will be £19,500 less. The 
amount of satisfaction afforded to the nation by the unfor- 
tunate individuals employed as flunkeys would be increased 
if they were set to farm-labouring ; since flunkeys are 
paid higher wages than farm-labourers, the national wealth 
as measured would be reduced by the change. Market- value 
is not an absolute measure of satisfaction ; it measures the 
satisfaction afforded by different things to the same in- 
dividual, it is no measure of satisfaction as between different 
individuals. The rich man's pound has the same influence 
on market-values as the poor man's pound, it represents 
a much smaller satisfaction ; hence a box at the theatre 
has the same value, and represents the same amount of 
wealth as measured as a quarter of wheat. The unequal 
distribution of wealth makes market-values inevitably and 
progressively false as a measure or indication of the satisfac- 
tion afforded by wealth ; to measure national wealth, there- 
fore, by totalling market- values is to get no measure of the 



428 ECONOMICS chap, xxm 

satisfaction afforded to the nation by wealth. If the 
national wealth as measured were doubled, it would be no 
proof of a doubling of satisfaction. It would be possible 
and useful to draw up different inventories of goods and 
services, having all the same total value, but yielding 
different totals of satisfaction. In fact market- value, the 
only objective measure of wealth we have, is so very rough 
and fluctuating a measure of satisfaction, that it is no 
measure of wealth from the point of view of society at all ; 
and it is misleading to place so much rehance as is placed 
upon it in the study of wealth. 

If we are to measure national wealth by totalling means 
of satisfaction, we need a unit of satisfaction, a thing which 
we do not possess. At most, therefore, two thousand milhon 
a year is a rough measure of the nation's economic poioer ; 
not of its product, but of its productive capacity ; not of 
the means of satisfactions afforded by the economic 
organisation, but of the command of them afforded by 
the economic organisation. The amount of satisfaction 
that the nation will derive from its economic organisation 
will depend, not only on the degree of productive power, 
but on its direction ; not on the volume only of the pro- 
duct, but on its nature ; not on the amount of wealth as 
measured only, but on its use. 



CHAPTER XXIV 

WEALTH AND WELFARE — ECONOMIC INFLUENCES 
ON WELFARE 



The Influence of Distribution 

We have to consider tlie influences exercised on welfare by 
wealth and ignored by the ordinary measurement of wealth. 
First the influence exerted by different uses of wealth. We 
can consider this influence under two heads : use by society, 
and use by the individuals who compose society. Use by 
society is the problem of distribution ; and distribution 
is conditioned to a large extent by the needs of production. 
The system of free enterprise is upheld as the best means 
of maintaining and increasing the production of wealth ; 
if free enterprise involves an unequal distribution of wealth, 
that inequality is condoned as providing the best incentive 
to enterprise. With the system of free enterprise as a 
productive organisation we have dealt elsewhere ; here it is 
necessary to consider only the influence of the inequality 
of wealth, which it involves, on the amount of satisfaction 
afforded by wealth. The imequal distribution makes 
market-values a false and misleading indicator of the satis- 
faction afforded by different kinds of wealth ; yet market- 
values are the sole indicator of the needs of society, followed 

429 



430 ECONOMICS chap. 

by producers under the system of free enterprise. Free 
enterprise, therefore, following market-values, is an auto- 
matic device for securing an uneconomical application of 
productive power, and preventing a maximum of satisfac- 
tion from being secured for a minimum of efiort and sacrifice. 
Anything that tends to equalise the distribution of wealth 
tends to lessen the vagaries of the indicator which production 
follows, and tends to secure a more economical application 
of productive power to satisfying wants. Taxation and 
laws of inheritance that tend to equalise wealth may check 
the growth of wealth in gross, and yet increase welfare by 
increasing the satisfaction afforded by wealth ; the super- 
tax, taken from the incomes of the rich and expended by 
old-age pensioners, will afford the latter a much greater 
amount of satisfaction than the former would have got from 
it ; the quarter of wheat on which the poor will spend a 
couple of pounds will afford a much greater satisfaction 
than the box at a theatre on which the rich man might have 
spent it. 

Welfare is influenced by the distribution of wealth in 
another way. Once the primary needs of physical existence 
are met, expenditure is governed very largely by social 
standards. People choose a house in accordance not merely 
with the requirements of health, but with the standard of 
house accommodation of their class. They choose clothes 
which will not only ensure warmth, but will also satisfy 
a certain standard of ostentation. They buy books, not 
to read — the books they read they get from the circulating 
library — but to conform to certain standards of furnishing. 
And poverty consists as much in inability to live up to the 
standards of one's class as in actual lack of wealth. Shabby 
clothes are a source of unhappiness, not because they fail 
to keep one warm, but because they make the wearer dis- 



XXIV ECONOMIC INFLUENCES ON WELFARE 431 

agreeably conspicuous ; if every one wore shabby clothes, 
as was the case in the Middle Ages, no one would object 
to wearing shabby clothes. Moreover, the standards of 
one class influence the standards of the class below, and so 
on through all the classes of society. A considerable part 
of the expenditure of every class, except the very richest 
and the very poorest, is governed, not by any rational 
judgment of what will give the truest satisfaction, but by 
the desire to do as other members of the class do ; and in 
all the intermediate classes there are people who feel poor, 
although they are not poor by any absolute standard. 
Now the concentration of wealth in the hands of a few 
enables that few to set a very high standard of expenditure, 
which influences the ideas of all the other classes. The 
riches of the rich intensify the poverty of the poor. Where 
wealth is less, but more evenly distributed, as in Denmark, 
equal satisfaction can be obtained from a smaller income ; 
every class in Denmark lives in a smaller house, has less 
furniture and probably fewer clothes, and spends less on 
amusements than the corresponding class in England, yet 
they certainly get no less satisfaction from wealth. Thus 
it is probable that the happiness that wealth gives depends 
as much on the distribution as on the absolute amount of 
wealth. The present age is unhappy not because it is 
poor — it is richer than any preceding age — but because the 
inequalities of wealth, which have become obvious to the 
most careless, have no basis in ethical principle. There 
are philosophers who try to bring ethical ideas into accord 
with this inequality ; but the basis of most Western people's 
ethical ideas are to be found in Christianity and democracy, 
neither of which gives any countenance to the inequality. 
Not what he has, but what he thinks he might have and 
ought to have, determines a man's state of mind. Hence 



432 ECONOMICS chap. 

the worker of to-day is discontented, and derives not the 
slightest comfort from the knowledge that in any earlier 
age his real income would probably have been less than 
it is. 

Another drawback to an unequal distribution of wealth 
is the opportunities it gives of tyranny. Wealth under 
any circumstances is power, and when it takes the form of 
ownership of the means of production, on which the manual 
worker is dependent for the opportunity of earning his 
livelihood, it is a dangerous power. The contempt into 
which the State is falling is due to the contrast between 
the political forms of democracy and the economic reality 
of oligarchy. A class of multi-millionaires is a standing 
menace to the supremacy of the State ; and the experience 
of beneficiaries suggests that a well-meaning millionaire is 
an almost greater nuisance than his wicked brother. 

II 

The Influence of the Use of Wealth and the Kind 
of Product 

Welfare, then, can be increased by a better use of wealth 
by society, in the form of a better distribution of it, as well 
as by an increase in the amount of wealth ; the ordinary 
computation of wealth is concerned solely with the measure- 
ment of the latter, and ignores the former. Similarly it 
ignores the even more important influence on welfare of 
the use of wealth by individuals. An increase of production 
obviously is no increase of welfare if the product is wasted. 
Waste in the sense of objectless destruction of product is 
rare ; but in a broad sense there is waste whenever wealth 
is applied to a use that gives less satisfaction than another 
use to which it could have been applied ; and waste in that 



xsiv ECONOMIC INFLUENCES ON WELFAEE 433 

sense is common. To prevent it, as much care would be 
needed in spending as in getting ; consumption would have 
to be organised as systematically as production; and as much 
care exercised in the choice of people to direct the organisa- 
tion. No such care is taken, and in consequence much 
production adds nothing to welfare. A man will work 
hard and increase society's wealth by building up an efficient 
business, and then waste the increase in maintaining his 
children \^ an idleness which they do not enjoy and which 
is not good for them. Workers are constantly speeded up 
and industry made more productive ; the additional pro- 
duct is no addition to welfare if the employer's share goes 
in ostentatious luxury, and the workers are driven by ex- 
haustion to spend their share in procuring excitement to 
relieve exhaustion. Often an increase of wealth merely 
cancels some existing means of welfare. An addition to 
wealth that takes the form of motors so speedy as to con- 
stitute a danger to life and a nuisance to the inoffensive 
pedestrian or cyclist may take away from the pleasure of 
walking and cycling more than it adds to the pleasure of 
those who can afford motors ; a colliery that blackens 
a country-side adds to material wealth only by destroying 
an immaterial source of welfare. 

Two kinds of waste or misapplication of wealth are 
especially important as influencing welfare without being 
indicated by the measure of wealth. The first is the applica- 
tion of production to objects which give an obvious and 
immediate satisfaction, to the neglect of objects that give 
a more lasting or intense, though less obvious, satisfaction. 
This is illustrated by the contrast between the valuations 
of the market and the valuations of the connoisseur. Good 
art gives not only a different satisfaction from bad art, but 
more satisfaction. A thing of beauty is literally "a joy 

2f 



434 ECONOMICS chap. 

for ever," while last year's fashions are the abomination 
of this. Modern industry gives us more furniture, more 
metal work, more carpets, more wall coverings, and more 
" decoration " than handicraft ; yet the connoisseur, the 
man who has made it his business to understand these 
things, prefers the quality of the age of handicraft to the 
quantity of modern industry. The view of wealth which 
counts only product encourages methods of production 
which are adapted to quantity rather than quality ; and 
freedom of enterprise encourages the supply of those 
pleasures which oSer gratification on the easiest terms. 
Poetry as a rule gives a more intense pleasure than prose 
fiction, but it asks a greater effort from the reader ; prose 
fiction has grown, therefore, while poetry is the pleasure of 
the few. For the same reason bad fiction is produced in 
greater quantity than good fiction ; for the same reason 
the cinematograph " drama," which asks of the observer 
an intellectual effort that could not task the most feeble 
minded, is displacing the novelette. 

Id the second place, the measure of wealth would be no 
measure of welfare, even if it represented the true amount of 
satisfaction afforded by wealth, because it ignores differences 
in kind of satisfaction. The definition of wealth on which 
the measurement of wealth is based regards the kind of 
wants as indifferent, looking merely to the quantity of 
satisfaction given. Wealth in this sense is a measure of 
welfare only on the Utilitarian view of welfare, that it 
consists in the greatest possible surplus of pleasure over 
pain ; it is only on this view that differences in hind of 
satisfaction can be ignored, and differences in quantity or 
intensity alone regarded. The amount or intensity of 
satisfaction offered by two forms of wealth may be equal ; 
they will count equally in the computation of the country's 



sxw ECONOMIC INFLUENCES ON WELFARE 435 

wealtli. Their contribution to welfare, on any except the 
Utilitarian view, need not be equal, since there may be a 
difierence between them which we express by the terms 
" higher " and " lower." Many satisfactions are what 
is called " demoralising," drunkenness for example : the 
means of obtaining them (provided they are not unlimited 
in quantity) count as wealth, and contribute to the total of 
national wealth ; to welfare they contribute nothing, but 
rather detract from it. Other satisfactions, without being 
bad in themselves, may interfere with higher satisfactions ; 
riches, for example, hamper a man's entry into the Kingdom 
of Heaven, and, on the view of welfare that attaches im- 
portance to the Kingdom of Heaven, are to be avoided ; or 
to take a more mundane example, comfort in modern cities 
can be carried to such extremes that health is impaired by 
want of exercise. 

Wealth then, as measured, is no criterion of welfare ; 
the direction of productive power is as important for welfare 
as its amount ; an increase of wealth may take such a form 
that welfare is not increased. The increase of wealth since 
the Industrial Revolution includes much that no one would 
be the worse without. Much of it is merely means of 
ostentation, which adds to the satisfaction of those who out- 
shine their fellows only so much as it detracts from the 
satisfaction of those who are outshone Much of it takes 
the form of machine-made ornament, which is neither 
individual nor organic to the object to which it is applied, 
and adds nothing to its beauty. The furnishings and 
fabric of a modern house of almost any class are plastered 
over with such futilities — all those trifles that are neither 
beautiful nor useful, give no satisfaction three days after 
they are bought, and get in everybody's way ; while those 
who can afford collect old furniture, and the only thing 



436 ECONOMICS chap. 

wHcli cannot be got is simplicity. The most expensive 
process in the making of pottery is tlie mechanical addition 
of the mechanical ornament that drives people to collect 
old china. The national income is further swollen by a 
host of things " made to sell," which attract pm-chasers by 
their sm'face finish but are useless for their ostensible 
object, and by all sorts of expensive processes and devices 
for manufacturing shams. We have no measure of utility 
except the meaningless measure of money, and very few 
standards ; hence no measurement can be made of the 
amount of this useless production ; but obviously it occupies 
no inconsiderable portion of the productive powers of the 
country. 

Ill 

The Influence of Work 

The ordinary measurement of wealth then gives us no 
reliable indication of the amount or value of the satisfaction 
afiorded by wealth. It ignores another influence which 
the economic organisation exerts upon welfare, by taking 
into consideration only the 'product of the economic organi- 
sation and seeking to measure that alone. The conditions 
of production, worh, in the widest meaning of the term, are 
as important for welfare as the product. Some slight 
recognition of this is to be seen in the attitude of the State 
to industry ; a certain minimum of sanitation, safety, 
and, in some cases, leisure is imposed ; but the interpre- 
tation given to " conditions " is so restricted that it is 
hardly an exaggeration to say that their influence on welfare 
has been forgotten by society. 

The influence of work on welfare is exerted through 
many channels ; the chief are perhaps its object, the nature 
of its 'process, and the nature of its control. The principle 



XXIV ECONOMIC INFLUENCES ON WELFAEE 437 

that the object of work is important to the worker is recog- 
nised in relief works. It is felt to be demoralising to set 
a man to useless work^ merely to make him work ; his self- 
respect sufiers if he is set to dig trenches for another man 
to fill. The same feeling underlies the use of such a word 
as " flunkey " as a term of abuse ; it is felt that the work 
of a flunkey is beneath the dignity of a man and must react 
on his character. If this feeling is sound; then the number 
of. workers whose self-respect would suffer, if they realised 
what they were doing, must be very great ; for the weavers 
who weave plush, and dyers who dye it, for the flunkey's 
breeches, are as useless as the flunkey himself. Specialisa- 
tion, by making it more and more difiicult to assign to its 
ultimate destination any piece of work, is breaking down 
this discrimination between occupations in accordance with 
their object ; the same firm may supply paper for Bibles 
and paper for betting contracts. At the same time 
specialisation, by distributing among a large number of 
workers the making of each single thing, takes out of work 
the handicraftsman's interest in the thing made ; it is 
possible to take in the making of a pair of boots some- 
thing of the artist's interest in the making of a picture ; 
it is difficult to take the same interest in the clicking of 
an upper to a sole. 

Object and process act and react on each other. An 
interesting object will be interesting to make ; while an 
interest in the making is likely to be reflected in the object. 
It is hard to find work in which the workman takes no interest 
at all ; but there are great variations in the intrinsic interest 
of work, and much work that has only a negligible interest. 
At one extreme is the work of the artist, an activity so 
satisfying that it is claimed (by the advocates of art for 
art's sake) that the consumer of the product need not be 



438 ECONOMICS chap. 

considered ; at the other extreme there are operations so 
mechanical as to call for no intellectual efiort and only a 
slight and uniform physical efiort. An ideal social system 
would give to every one a share of both kinds of work. 
Man is not a machine^ and to treat him as one is to make 
him something less than a man. If the process of work 
is to contribute to welfare, it must have variety. Variety 
is needed to give scope for initiative and choice ; work 
without variety exercises only a part of the man, and the 
faculties which are not exercised tend to atrophy. Art 
is good work, because it has an infinite variety ; it is an 
unending exploration ; once the artist begins to repeat 
himself, to do the same kind of thing in the same way over 
and over again, his work becomes conventional and loses 
its quality. Bad work is exemplified by the tending of some 
automatic machines ; the worker is part of the machine ; 
there is no room for the exercise of choice, no scope for 
originality ; what he shall do and how he shall do it is 
determined for him, and it is his business to fit himself to 
the routine of the machine ; once the routine is learnt, no 
further call is made on his intellectual faculties, and the 
range of movements may be so narrow that only a small 
part of his physical powers are exercised. The efiect on 
such a worker of the mechanical monotony of his work may 
be counteracted by influences outside his work, but his work 
is such that it contributes nothing to the development of 
his faculties ; his work is so much time taken out of his life, 
so much vital energy turned to waste, so far as the develop- 
ment of himself is afiected. The creative worker by con- 
trast is most alive when at work, and receives a full reward 
for his work in the pleasure of it and the addition it makes 
to his personality, whether he be paid for the product or 
not. 



xsiv ECONOMIC INFLUENCES ON WELFARE 439 

With the process of production the control of production 
is closely connected. Where the process of production 
is subdivided and subdivided, and the human element 
linked up with power machinery, the individual worker 
will have little control over his life at work, he will have little 
freedom in the sense of self-direction, little independence. 
The speed, order, and conditions of work will all be set for 
him ; initiative, responsibility, direction will be concentrated 
on the few and taken out of the work of the many. Special- 
isation involves the subordination of the detail-workers to 
the organisers of industry, and such subordination gives 
an opening for tyranny ; the modern worker has enlisted 
in an army in which discipline, the subordination of the 
mass of individuals to authority, is just as necessary to the 
system as it is in any military force. When capitalism 
— ^the private ownership and control of the non-human 
element in production — is added to specialisation, the 
individual worker's freedom is limited still further ; but 
even with public ownership of capital, the system involves 
the subordination of the many to the few, it affords openings 
for speeding-up, bullying, victimisation ; public employees 
are not the most contented class of the community. Where 
on the other hand the process of production is not sub- 
divided, so that work retains its variety, there the in- 
dependence and self-direction of the worker survive ; the 
same person has to decide what to do, how to do it, at what 
rate to work and how co-operation with other workers shall 
be organised. 

According to most views of welfare, it is better for 
people to control their own actions than to have all their 
actions dictated to them ; initiative is better than blind 
acquiescence in the initiative of others. This belief is the 
basis of political liberty or self-government ; the right of 



440 ECONOMICS chap. 

every one to a share in the government of the country is 
regarded by the democrat not only as a means of securing 
a just and efficient government^ but as a fundamental 
attribute of citizenship ; democracy or political liberty 
includes the right to misgovern oneself. Slavery is regarded 
as an evil and forbidden on similar grounds ; the slave has 
no legal control over his own activities. If work then is to 
contribute to welfare directly^ and not only indirectly through 
its product, the control of work must be diffused as widely as 
possible, the work of " management " must be distributed, 
methods of voluntary co-operation devised to take the place 
of the direct imperative of the captains (and the other 
officers) of industry. It should be an aim of economic 
organisation to reserve to the individuals in it as ample 
a control over their own activities during work as is con- 
sistent with the end of work being achieved and wealth 
produced ; the two aims must be balanced against each 
other, and neither be sacrificed to the other. 

IV 

The Sacrifice of Producer to Product 

In the light of this double end of the economic organisa- 
tion, certain forms of organisation, which are condemned 
when judged merely by their productivity, acquire a new 
interest, since they may contribute to welfare directly, out 
of all proportion to their productivity. Small firms multiply 
in industries in which all the economic advantages seem to 
lie with large firms, because enterprising men prefer to 
be their own masters. The " little master " system of 
manufacture, when the little master is really his own 
master and not the slave of the middleman, draws strength 
to survive from the same motive. The hand-loom weavers 



XXIV ECONOMIC INFLUENCES ON WELFARE 441 

of the early nineteenth century, even under the pressure 
of extreme poverty, refused to enter the factories, where 
their lives would be ordered by th,e factory bell ; and the 
peasants of the same generation, who lost the status of 
independent farmers through enclosures, felt themselves 
wronged in spite of the experts, and transmitted the feeling 
to their descendants. 

An importance is sometimes attached by statesmen to 
agriculture, and especially to small holdings, which is not 
justified by the ordinary view of production. If the pro- 
ducts of an industry can be obtained from abroad more 
cheaply than they can at home, it is considered good 
policy to import them, and to develop for export some in- 
dustry for which the country has greater advantages ; in 
the case of agriculture alone. Free Trade politicians are not 
content with this policy, and propose all sorts of subsidies, 
such as loans and railways below cost price, and inter- 
ferences with the normal course of economic arrangements, 
such as State-fixing of rent and wages. In the case of other 
forms of wealth the owner is allowed to use it as he will, 
not so in the case of land , it is not wrong to keep for one's 
pleasure a twenty-roomed house in an overcrowded city, 
but apparently it is wrong to keep for one's pleasure land 
that could be used for small holdings. The exceptional 
position among occupations thus attributed to small 
agriculture is often a mere piece of sentimentalism ; but 
it has sound justification. The work of a farmer has more 
variety, more room for initiative and self-direction than the 
work of the ordinary artisan or foreman ; and agriculture is 
the chief branch of production in which economic advantages 
are not on the side of large-scale production. The German 
statesmen of the early nineteenth century who preserved 
their small farmer class had a wider conception of welfare 



442 ECONOMICS chap. 

than the English statesmen who sacrificed their peasant 
class to increase the productivity of land. 

From this point of view again the co-operative movement 
in industrial organisation acquires an enhanced importance. 
Co-operative stores to a slight extent and co-operative associa- 
tions of producers to a very great extent distribute the work 
of industrial management ; they avoid that subordination 
of companies and regiments of workers to the will of a single 
" captain " of industry ^ which is the mark of private em- 
ployment. The very difficulty of organising them is an 
additional reason for persisting in the attempt to organise 
them, since the difficulty consists in inducing people to 
work together without compulsion, and nothing develops 
the pleasanter sides of human nature more efiectively than 
the practice of such voluntary co-operation. The moral 
efiects of the system are a more important part of its claim 
than its economic results. 

Work then^ if it is to contribute to welfare directly^ 
should be such as to develop the worker's personality. For 
this it must have variety, it must be responsible, it must 
afford him scope for initiative and self-direction ; there 
must be individuality in the object, the process, and the 
control of work. If all work were of this nature, the curse 
of Adam would be overcome. It is impossible that all 
work should be of this nature ; but much more attention 
might be paid to this influence on welfare in schemes of 
social reconstruction. The principle lacks recognition that 
workers are entitled to be treated as persons, not merely 
as " hands " ; William Morris met with little response when 
he preached the gospel of work as a way of life as well as a 
means of livelihood, a gospel he could preach because he 
practised it. The chief tendencies of modern industry are 
against the recognition of this principle, because the under- 



XXIV ECONOMIC INFLUENCES ON WELFARE 443 

lying principle of them is specialisation. Specialisation is 
enormously productive ; product is obvious and can be 
measured, while the other influences of the economic organi- 
sation on welfare cannot be measured and are easily over- 
looked. Requiring a large and uniform output, specialisation 
destroys individuality in the object of work ; by subdividing 
the process of manufacture, it prevents the workman fi-om 
having an interest in the manufacture as a whole ; by 
simplifying processes it makes them mechanical, and there- 
fore fit work for machines, not for men ; and instead of 
difiusing control and responsibility it concentrates them on 
a few " captains of industry " on the specious ground of 
efficiency — efficiency meaning, in nearly every case, the 
sacrifice of the worker's humanity to the needs of material 
production. In pursuit of the economies of specialisation 
individuals have, by private contracts, created an economic 
system which no individual can control, and which controls 
every individual. 

There are two reasons especially why the influence which 
the nature and conditions of work exert upon welfare needs 
attention. The first is that the product, to which specialisa- 
tion tends to sacrifice the producer, is in so many cases 
worthless measured by any but commercial standards ; 
as we have seen, many of the goods and services that con- 
stitute modern wealth, contribute nothing to welfare, and 
may even by destroying the taste for better things detract 
from welfare. The other is that work is an influence that 
none of the masses escape. Except the home, it is the 
most important social influence we have to reckon with in 
the formation of character. The elementary school reaches 
all, but only up to the end of childhood ; other forms of 
education touch only a fraction. Organised religion touches 
an even smaller fraction than the continuation school. Con- 



444 ECONOMICS chap. 

scrip tion is the exception in English-speaking countries. 
Even the home, under the pressure of the economic system, 
which treats the individual, not the family, as the unit of 
society, is losing the influence it possessed. On the other 
hand, work must always have the first claim on a man's 
energy, time, and ability. Leisure and all its possibilities 
may be, and in many cases will be abused ; work is con- 
ditioned by forces which the individual does not control. 
If, therefore, society organises industry so as to make work 
mechanical, the people will be mechanical ; if it allows 
no scope for the exercise of the aesthetic faculties, these 
faculties will tend to atrophy ; if initiative and responsi- 
bility are taken out of the work of the ordinary man and 
concentrated on " captains of industry," the ordinary man 
will become a creature of routine, incapable of responsi- 
bility ; and society will not be sure even of a continued 
supply of " captains." The wise use of leisure may counter- 
act these tendencies ; but there is no certainty that leisure 
will be used wisely, while the influence of work is certain. 

The influence of work on welfare is not without recognition. 
William James described the introduction of manual training 
as the most colossal improvement which recent years have 
seen in secondary education. The separation of physical 
and mental labour which modern industry favours is seen 
to be bad for both manual worker and brain worker. Edu- 
cationalists are beginning painfully to reproduce in the 
schools the kind of training that handicraft used to give at 
work ; an educational system is a necessity only under a 
system of uneducative work. Before the rise of modern 
industry, much more importance was attached to the point 
of view of the producer. Industry was regulated by associa- 
tions of producers, gilds and companies, to whom was left the 
regulation of conditions and quality. The manual worker 



XXIV ECONOMIC INFLUENCES ON WELFARE 445 

has always refused to adopt the economist's way of looking 
at industry solely from the point of view of the consumer ; 
for him conditions are as important as wages ; speeding-up^ 
overtime; petty tyranny, and victimisation are evils as great 
as low wages ; the trade union is for him the fundamental 
social organisation, because it is elastic in its objects and 
can be directed against any of these evils. Hence the 
significance of the latest manifestation of the democratic 
spirit, Syndicalism, the claim that the workers shall control 
the conditions of work. 

To criticise Syndicalism on the ground that the adopt- 
ing of its proposals would decrease the product of industry 
is beside the point ; its criticism of society is based on 
the view that conditions are as important as product. 
To object that its practical proposals are visionary and 
unpractical, even if true, does not afiect the force of 
its criticisms ; the proposals of Owen and the Utopian 
socialists were unpractical, but their criticism of anarchic 
individualism in industry was sound, and their assertion 
of the need of social control of industry has received the 
sanction of subsequent legislation. The attitude to reform 
against which Syndicalism is a protest accepts the materialist 
assumption of the present economic system, that economic 
welfare depends on the amount of product ; it is illustrated 
by the remark sometimes made that the Industrial 
Revolution solved the problem of production, while the 
task of this age is to solve the problem of distribution. So 
far from the Industrial Revolution solving the problem of 
production, it would be truer to say that it created it. 
The whole-hearted acceptance of the principle of specialisa- 
tion, which was the essence of the Industrial Revolution, 
leads inevitably to the sacrifice of the producer to the 
product ; a reformed distribution, desirable in itself, would 



446 ECONOMICS chap, xxiv 

merely compensate him by giving him a larger share of the 
product — in much the same way as a Eailway Company 
cripples an employee for life, and " compensates " h.im with 
a payment of a couple of hundred pounds. The Industrial 
Revolution has left the United Kingdom with the liability 
on its hands of a population seven times as great as it was 
before — a population so dense that society cannot dispense 
with specialisation, in spite of its evils. From the point 
of view of those evils, however, socialism is a mere palliative ; 
indeed the State, when it takes over any service, exaggerates 
them, carrying specialisation to hitherto unknown lengths 
by the creation of " experts," and by centralising responsi- 
bility and initiative to a degree unknown in private industry. 
Aristotle defined a slave as a " living tool," and the phrase 
describes precisely the wage-earners in industries that have 
passed through the Industrial Revolution ; the majority of 
Government employees are in the same category. 



CHAPTER XXV 

WEALTH AND WELFARE — BUSINESS AND MORALITY 



Welfare regarded as independent of Wealth in some 
Systems of Morality 

We have seen that money, the measure of wealth, is a very 
inadequate measure of the welfare afforded by the economic 
organisation ; the product of that organisation is only one 
channel through which it influences welfare. How little this 
measure may tell us about welfare, however, we can realise 
only when we remember that in some important ethical 
systems wealth is treated as a very subordinate influence 
on welfare, welfare being attainable only by subordinating 
wealth to other influences on welfare. It falls outside the 
scope of economics to define welfare, but it is necessary 
to an understanding of the limits of economics to point 
out that such views of welfare and wealth are held. The 
sources of human satisfactions or welfare may be divided 
roughly into two classes, internal and external sources ; 
wealth is one of the external sources. Materialism is the 
subordination of the internal sources of satisfaction to the 
external ; most religions exalt the internal over the external, 
and teach that welfare lies in the former, to which the 

447 



448 ECONOMICS chap. 

latter must be sacrificed : " The Kingdom of Heaven is 
within you." 

The religious view of wealth is not so inconsistent 
with common practice as at first sight appears. Wealth 
seems to be an aim of every one and the aim of many. 
Many, however, who seek it seek it merely as a means to 
other things. A Cecil Ehodes will seek it as the means of 
realising his political ideals ; and others, without his ideal- 
ism, will seek it as the index of social success. Under the 
system of free enterprise, wealth is the chief means of power 
and influence over others ; if other means were devised, 
they would be sought by the people with ideals to realise, 
and the people with no clear ideal, but only personal 
ambition to satisfy, would follow suit. In England an 
ambitious man gives up accumulating wealth after a time, 
and goes into politics or buys a title ; in America, where 
there are no titles, and politics are often subordinate to 
finance, he goes on accumulating wealth indefinitely, not 
for its own sake, but as the only source of influence and the 
only index of success. The Christian view of wealth would 
seem to be that wealth is less important for welfare than 
the internal sources of satisfaction ; an increase of wealth 
is not necessarily an increase of welfare, and wealth should 
not be allowed to stand in the way of other kinds of welfare ; 
it is not impossible for a rich man to enter the Kingdom of 
Heaven, but his riches are as great an obstacle to entering 
the Kingdom as a camel's load is to passing through a 
postern gate. It is not of course contended that an increase 
of wealth brings no satisfaction and adds nothing to welfare, 
but only that satisfactions derived from external sources are 
the more transient, and to build one's welfare on the posses- 
sion of wealth is to hold it by a precarious tenure. And 
this view of wealth is supported by the practice of the great 



XXV BUSINESS AND MORALITY 449 

mass of mankind. Even in the countries that have passed 
through the Industrial Revolution, the working classes and 
the professional class seek a secure sufficiency rather than a 
constant increase of wealth ; their chief interests lie in other 
directions. The rich use their riches to deprive themselves 
of the comforts of civilisation and to gain opportunities of 
experiencing the hardships and excitement of primitive 
life, hunting big game or climbing mountains ; the schools of 
the rich, in England at any rate, teach hardship rather than 
comfort. The rich as a class are no happier and no better 
than the poor as a class. 

If we compare different ages and countries, we are 
struck by the apparent unimportance of wealth. The 
materialist regards the vulgar plenty of the twentieth 
century as greatness ; others will regard its art as a 
better index of an age or a country's temper. Whichever 
is right, the two great ages of art, the two periods when 
craftsmen were artists and the appreciation of art was 
general, were ages of extreme material poverty ; and few will 
assert that the age of Arkwright was greater than the age 
of Pheidias, the civilisation of Chicago than the civilisation 
of Athens ; few, who have studied both and compare 
achievement with opportunity, will place the art of the 
thirteenth century below the art of the Victorian age, the 
age that built the cathedrals below the age that restored 
them. As society has grown richer, art has become more and 
more the concern of little cliques and coteries, less and less 
a part of the everyday life of ordinary people, until to-day 
we have countries like the United States, so rich that its 
Whistlers and Sargents fly to the poorer countries of Europe. 
If religion rather than art be taken as index of the age or 
country's temper, the comparison will be even less flattering 
to the richer modern countries. 

2g 



450 ECONOMICS 



II 

The Economic Organisation not necessarily a Reflection 
of Current Moral Standards 

It is sometimes maintained that the considerations which 
have occupied us in the last few pages are both irrelevant 
and unnecessary. They are irrelevant^ it is maintained, 
because they are ethical, not economic, considerations. 
Economics is the study of the social organisation for satisfy- 
ing wants, the means of satisfpng which are limited in 
quantity ; the organisation can be studied, and its efficiency 
judged without going into the question of the kind of wants 
society seeks to satisfy. They are unnecessary, because the 
system of free enterprise ensures automatically that the 
economic organisation and its products wall conform to 
the standards of taste and conduct of the time. Those 
things are made which are wanted, since there is freedom 
to make anything ; those methods of production are 
adopted which society thinks best, since the State prescribes 
no set form of organisation ; those economic relations are 
established that give a maximum of convenience, since the 
individuals in society are left free to establish what relations 
they think best. The economic organisation is responsive 
to every change in the direction of people's wants and 
ideals, and is therefore the necessary outcome and reflection 
of current views of welfare. Business is neither moral nor 
immoral ; it is neutral, directing itself to meeting whatever 
wants are expressed. If the results of the economic system 
are repugnant to our moral sense, we must take steps to 
change the moral ideas of the people whom the economic 
system serves ; the economic system being merely responsive 
to demand, we must change the nature of demand. Reform 



XXV BUSINESS AND MORALITY 451 

must come by changing the public's standards of satisfac- 
tion ; to attack the organisation for satisfying wants is to 
tinker with symptoms and to neglect the cause of the evil. 

This objection to our argument contains an important 
half-truth. Undoubtedly to a certain extent the economic 
organisation is responsive to changes of taste and conduct, 
and its works are a reflection of them. If people are bad, 
under any system the products of industry will be bad ; if 
they are careless of beauty, the products will be ugly ; if 
they are careless of one another's rights, there will be oppres- 
sion and injustice ; if they are selfish, there will be an un- 
equal distribution of the benefits of the organisation. Con- 
versely, any improvement in morals will affect the economic 
organisation. The greatest social evil of the day is not the 
inequality of wealth, but the selfishness and insensibility 
to the sufferings of others that makes all attempt to secure 
greater equality so difficult. If the Christian Churches' 
preaching of the unimportance of wealth and the duty of 
unselfishness were effective, the path of reform would be 
smoothed. The objection is important, too, because it 
underHes much of the opposition to all attempts to moralise 
the economic system by State action. The system, it is 
thought, is an automatic system ; free enterprise ensures 
that it will reflect current morality, and it can be improved 
only by raising the level of current morality. 

In spite, however, of the half truth it contains, the 
objection is unsound. It exaggerates the responsiveness of 
the economic organisation to changes in standards — we are 
bound to examine how far it is responsive ; it is quite 
without justification in assuming that private arrangements 
between individuals are either the only or an adequate way 
of moralising the economic organisation ; and it ignores 
the reaction of the economic organisation on standards of 



452 ECONOMICS chap. 

taste and conduct. The economic organisation is responsive 
to demand, but demand is not the same thing as want or 
need ; demand is no guarantee of desirability by any 
standard other than those of the market. Not need but 
purchasing power gives the direction which production 
shall take. The economic system is responsive to people's 
views only in so far as they can exercise purchasing power. 
Those who devote themselves to altruistic objects and 
neglect the pursuit of private wealth will exercise little 
influence on the system through the ordinary channels on 
which the policy of free enterprise relies ; a St. Francis, 
vowed to poverty, would have no influence through those 
channels at all. Those, on the other hand, who subordinate 
everything else to money-getting will exercise the greatest 
influence. The organisation would be responsive to need, 
it would reflect the moral and aesthetic standards of the 
age, only if wealth were equally distributed. 

Even if the condition that purchasing power must be 
fairly evenly divided were satisfied, the system of free 
enterprise would not ensure conformity of the economic 
organisation to the moral standards of society. Only if 
people, when they made their purchases or entered into other 
economic relations, did exactly what they knew or thought 
to be their highest interest would such conformity arise 
from freedom of enterprise. The argument that fi'ee 
enterprise is all that is needed to ensm-e conformity of the 
economic organisation to current standards ignores the 
unfortunate tendency in human beings to do what they know 
to be bad for them and to leave undone what they know 
to be good for them — the tendency that theologians call 
" original sin." The argument is the argument of anarchy ; it 
goes further than the advocates of free enterprise recognise, 
and would leave no room for the State at all. If economic 



XXV BUSINESS AND MORALITY 453 

relations and activities can be left to the " free enterprise " 
of individuals, and the State be confined to enforcing their 
private contracts, so may other relations and activities. 
If " free enterprise " or laissez faire will secure the con- 
formity of industry to moral standards, why not of every- 
thing else ? Why not leave the relations of the sexes to 
unrestricted freedom of enterprise ? 

Indeed, the policy of free enterprise or laissez faire is an 
expression of the same social philosophy, and based on the 
same conception of human nature, as the policy of " free 
love." That conception is the rationalist conception, on 
which utilitarian individualism was based — the conception 
that people will do what is reasonable without assistance, 
so that all that is needed is to set them free to pursue 
their enlightened self - interest. On this conception of 
human nature all laws are unnecessary. Laws, so far 
as they are good laws, require people to do only what is 
reasonable and in the best interests of the community : 
if people can be relied on to do what is reasonable and 
in their best interests, just because it is reasonable and 
in their best interests, laws which force them to do 
so are obviously not needed. In practice the fact that 
a thing is reasonable and to their interest is not sufficient 
to ensure that people will do it : most people, if they 
are candid, will sometimes confess with St. Paul : " That 
which I do, I allow not : for what I would, that do I not : 
but what I hate, that do I." In minor matters as well 
as in major — they take more drink than is good for them, 
food which they know will disagree with them, buy clothes 
they cannot really afford, idle when they know they ought to 
be working, sit up when they know they ought to be in bed, 
lie in bed when they know they ought to get up, and hurry 
into their clothes when they know a cold bath would be good 



454: ECONOMICS chap. 

for them : and in their economic relations they display the 
same human, if irrational, weakness. To overcome this 
tendency they need all the supports they can devise, and the 
State is one of the strongest supports they have devised. 
Everybody knows that it is bad to steal, to kill, to commit 
bigamy, to exceed the speed limit ; but we do not rely on 
that knowledge to prevent these crimes, and we have there- 
fore made arrangements through the State to prevent them. 
We are constantly passing laws to register a rise in the 
level of our morality and prevent any lapse below it in the 
future. Not only do we make secure in this way advances 
we have made, but we habitually use legislation to screw 
up the level of morality a little higher than it is. No 
department of human activity that has a social aspect can 
be exempt from this action of the State, and industry to-day 
is of all activities the most social. If all men were Christians, 
economic relations might perhaps be left to the unregulated 
enterprise of private contract, because all men would have 
been cured of original sin, this tendency to sacrifice their 
higher interests to immediate gratification or sheer inertia ; 
as they are, however, men cannot dispense with the checks 
they impose on their impulsiveness and selfishness through 
the machinery of the State. The moral standards of 
society embody the average conception of our highest 
interests : they will not for that reason by itself have an 
efiective authority over the individual, but require all the 
buttressing that the State, law, religion, and education can 
do to uphold them. 

We cannot therefore ignore the bearing on wealth of 
different conceptions of welfare, on the ground that under 
a system of free enterprise the economic organisation and 
its products will automatically conform to the current 
conception of welfare and reflect every change in it. To 



XXV BUSINESS AND MOEALITY 455 

the extent to which enterprise is free, we shall expect the 
morality of business to fall below the moral standards of 
the time, and we shall not be surprised to find that the 
economic organisation in the past has been moralised by 
the direct action of the State quite as much as through 
the economic actions of individuals : the abolition of slavery, 
the reform of the early factories, the abolition of infant 
labour in mines, the regulation of dangerous trades, the 
prevention of deleterious adulteration, the prevention of 
excessive drinking, to take only a few instances, have all 
needed the intervention of the State. 

Ill 

Reaction of the Economic Organisation on Moral Standards 

Nor can we exclude all consideration of difierent views 
of welfare on the ground that wealth and welfare are distinct 
and can be studied each in abstraction from the other. The 
two things can, of course, be separated for purposes of study, 
but not permanently, because they are not distinct : the 
economic organisation is not the mere outcome of our con- 
ception of welfare, it reacts upon it. Difierent systems of 
morality produce difierent types of economic organisation, 
but, just as truly, difierent economic systems produce different 
types of morality ; the economic organisation is not like a 
motor that will take us anywhere, it will take us only in 
certain directions, and may even run away with us. The 
reaction of the economic organisation on social standards of 
conduct is similar to the more obvious reaction on standards 
of taste. It is easily seen that it is only nominally responsive 
to aesthetic demands ; it is adapted to producing quantity 
so much more than quality, " standard " mechanical 
articles so much more than individual and characteristic 



456 ECONOMICS chap. 

articles, that society is forced in practice to take the former 
instead of the latter ; taste is formed on the objects it 
contemplates, and smooth finish comes to be preferred to 
vigour of design, the novelty of transient fashion to true 
originality based on tradition. In the same way the 
economic organisation facilitates certain kinds of conduct 
and favours the development of certain types of character, 
and handicaps other types of character. The direction 
which its influence takes is due to the identification of 
wealth with product. Wc have seen that it makes increase 
of product the sole end of its organisation ; the principle on 
which it bases distribution is productivity or contribution 
to product ; it estimates the increase of wealth solely by 
measuring product — so far as it can be measm'ed. Now 
if we treat product alone as wealth, and arrogate the term 
wealth, which in a broad sense means anything that satisfies 
a want, to product, which covers only external sources of 
satisfaction, inevitably we suggest that the internal sources 
of satisfaction are not wealth, we give a materialistic tendency 
to our aims and values. This the present economic syste,m 
does, because it is based on this narrow conception of 
wealth. 

Certain incidents of the system accentuate the tendency 
to materialism. The first is that wealth in this narrow 
sense is definite and measurable. There are other scales 
of value — moral, aesthetic, political — in which actions and 
qualities which have a low economic value — self-sacrifice, 
heroism, beauty, " the pure, gem-like flame of devotion to 
art," for example — have a high place ; but economic 
values are the only values definitely measured. The 
measure means little, the definiteness disappears when we 
look beneath the surface and find that economic values 
change with every change in the distribution of wealth ; but 



XXV BUSINESS AND MORALITY 457 

wealth retains this advantage over internal sources of 
satisfaction^ that it is subjected to a quantitive measure and 
stated in terms of a unit. This superficial definiteness 
gives economic valuations an advantage when they come 
into conflict with other valuations, because the influence of 
an idea on conduct depends very largely on its sharpness 
of outline ; definiteness commands assent, while vagueness 
invites questioning. When, therefore, a community or an 
individual has to choose between a course of action which 
will add to wealth and a course of action required by a 
vague but just sense of honour or duty, the fact that the 
advantage of the former can be stated in terms of pounds, 
shillings, and pence gives it an influence it would not other- 
wise exert. The influence is exerted most frequently, 
however, when different conceptions of advantage are com- 
peting and there is no obvious conflict between advantage 
and duty ; in expenditure on education, for example, the 
appeal of technical education is nearly always more forcible 
than the appeal of liberal education, because the results of 
the former can be stated in the addition of so many pounds 
a year to the earning capacity of the student, or the addition 
of so many pounds' value to the trade of the town, while 
the latter merely makes better men and women. Additions 
to wealth, being measurable, are spoken of as " solid," 
" material," or " practical " advantages ; all other additions 
to welfare are lumped together as " matters of sentiment," 
by implication unreal, unpractical, and immaterial. The 
economic measure is a useful aid to the study of wealth, it 
becomes a danger when its limitations are ignored ; if 
science is measurement, wisdom is the appreciation of that 
which cannot be measured. 

A second incident of the present economic system which 
accentuates its materialistic tendency is the insecurity of 



458 ECONOMICS chap. 

the individual's economic position under it. This insecurity 
is claimed as an advantage, since it exerts a constant 
pressure on the individual to work, and so ensures the 
maintenance and increase of the flow of wealth. The 
organisers of production have to " get on or get out," the 
lazy among the working class are kept to their work by 
the fear of unemployment, the investing class are compelled 
to watch their investments, and therefore to apply their 
capital to the most productive uses, by the losses that 
quickly attend bad management of a company. No one 
is guaranteed his position, his income, his work, or his trade 
connexion ; each is left to get out of the economic organisa- 
tion only what the competition of others will allow him to 
get. Two results follow : first, the minimum of wealth, 
which is necessary to a reasonable life and with which 
idealists of all sorts would be content, can be secured only 
by a constant struggle to get more than the minimum. A 
man may be genuinely anxious to take no thought for the 
morrow ; but he has his living to think about, and a living 
can only be secured by constant taking of thought for the 
morrow. However little a man cares about wealth he is 
forced to be constantly thinking about it ; hence wealth 
and wealth-getting activities have an importance in modern 
life that bears no necessary relation to their contribution 
to welfare. Secondly, the increase of wealth which the 
system induces is unevenly distributed ; if the poor do not 
get poorer, the rich get richer. Hence social standards of 
expenditure are constantly upset ; the pace is made by the 
energetic and acquisitive, and the great mass of ordinary 
people, who would be content with what they have if only 
these others would be content also, are made to feel poor 
by comparison. A system based on contract rather than 
status may make for the increase of wealth ; but happiness 



XXV BUSINESS AND MORALITY 459 

depends more on security of status than on increase of 
wealth. 

A third incident of the system, strengthening its material- 
istic tendency, is its method of distribution. The essence 
of morality, on any except a crude materialist view of 
morality, lies in distinguishing between kinds of satisfaction ; 
the essence of the present economic system is that it makes 
no distinction at all between kinds of satisfaction in dis- 
tributing rewards. The principle on which the distribution 
of income is based, so far as it is based on any principle, 
is that of productivity ; the aim of the system may be said 
to be to secure for each a share of the product proportionate 
to the contribution to production made by his labour or his 
property ; and anything that satisfies a want, without dis- 
tinction of kind of satisfaction, ranks as product. We pay 
a publican more for making a man drunk than for keeping 
him sober. In taking this attitude the economic system 
may merely reflect current morality and taste. We have 
seen reason for thinking that it does not, since it responds 
to casual impulse rather than to deliberate choice ; but 
whether it reflects current morality or not, it does ignore dis- 
tinctions in kind of satisfaction, and by so doing inevitably 
suggests that distinctions in kind of satisfaction are negligible. 
We need not believe that the hope of material reward is the 
only motive of action in order to recognise that the distribu- 
tion of material rewards influences action ; if, therefore, 
in the distribution of the material rewards at the disposal 
of industry the distinction between permanent services and 
transient satisfactions is ignored, the distinction between 
them will be weakened in the public mind. 

Further, while the principle of the present system of 
distribution is contribution to product, there are many ex- 
ceptions to the principle. A considerable number of incomes, 



460 ECONOMICS chap. 

we have seen, consist of payments received for no service, but 
the reverse of service ; monopoly profits secured by restrict- 
ing supply, speculative profits made by producing artificial 
price-fluctuations, the unearned increment of land withheld 
from the market during the growth of a town, make in- 
dividuals rich at the expense of the community. Riches 
so obtained, however, have the same purchasing power as 
riches obtained by serving the community ; they give their 
owner the same influence over the lives of other members 
of the community. Hence the distinction between social 
and anti-social effort tends to be obliterated ; wealth is 
respectable however won, and great wealth is honoured, 
because it is powerful, whatever its source. The extreme 
complication of the modern economic system helps this 
confusion. It is often difficult to ascertain how wealth is 
acquired, difficult to follow out all the effects of a certain 
way of acquiring wealth ; it is easier and much simpler to 
give up the attempt to discriminate, to lump together all 
methods of making wealth, and to concentrate one's en- 
deavours on securing a good use of wealth. It is increasingly 
difficult for the investor and consumer to make sure that he 
is not profiting by native slavery, sweating, or some other 
way of exploiting the weak. Because industry is social 
the individual seems helpless in the face of its evils, and 
the feeling arises that morality and business are something 
apart, that business is something outside the scope of the 
ordinary canons of morality. 

IV 

Materialistic Tendency of Economic Influences To-day 

In considering the action and reaction on each other of 
the economic organisation and morality, it is difficult to 



XXV BUSINESS AND MOKALITY 461 

disentangle cause and efiect ; so much, however, is clear, 
that the economic organisation, by lending itself so readily 
to the materialistic tendencies of society, strengthens them 
at the expense of the idealist tendencies. A public-house 
at every street corner may not cause drunkenness, it does 
very seriously increase the difficulties of the drunkard who 
is trpng to reform himself ; in the same way an economic 
organisation which serves all kinds of wants indifferently 
and rewards all kinds of satisfactions indifferently may 
not cause materialism, but it certainly strengthens any 
tendency to materialism there may be in society. Material- 
ism may of course be right, pleasure may be the true end of 
life ; here we are only concerned to point out the tendencies 
of the present economic organisation, and these are to 
support materialism. 

The extent to which the economic system influences 
the conception of welfare may be overlooked, because it 
seems absurd on reflection to identify wealth, the means 
of welfare, with welfare itself ; any one who asks himself 
the question what wealth is for, must perceive that it 
is only a means to something else. So few people, how- 
ever, do ask themselves the question ; the identification 
of wealth and welfare is unconscious ; the belief is not 
avowed. The existence of the belief, however, is to 
be traced in its effects. The pursuit of wealth, by the 
individual or the community, becomes habitual ; and the 
question how far the satisfaction given by any increase of 
wealth is worth the trouble of obtaining it, is seldom raised. 
Progress is conceived as the mere multiplication of material 
things ; and countries which have thought more of the 
use of wealth than its increase, and work to live instead of 
living to work, are stigmatised as " unprogressive." Every 
social reform has been opposed on the ground that it might 



462 ECONOMICS chap. 

" dry up the springs of wealth/' and the advocates of the 
reforms have usually taken the same ground as the opponents 
and argued that the reform would bring no decrease in 
wealth. The system of free enterprise, in which no one's 
status is secure and peace is not a harmony, but merely an 
equilibrium of hostile forces, is defended (and often criticised) 
solely ft'om this point of view. Statesmen advocate the 
feeding and medical treatment of school children, not on 
the ground that the children suffer, but on the ground that 
the expenditure will be an " investment," and will increase 
wealth in the future ; their true motive may be sympathy 
for the children, but they dare not avow it and must plead 
material expediency. Continuation schools are usually 
treated as an aid to industry, and their work made narrowly 
technical. Frequent complaints are made that elementary 
education is not equally " practical " or " useful," which 
means equally adapted to subserve the needs of industrialism. 
Attempts are even made to capture the universities for the 
same mean ideal, that man exists for production and the 
aim of education must be to make ever more efficient pro- 
ducers ; an eminent educationalist has defioied universities 
as " the technical schools of the brain- working classes ! " 
It is impossible to make some people see that as great an 
addition to welfare is made by teaching a boy to enjoy a 
book as by teaching him to print or bind it, by giving him 
a love of some art as by instructing him in some technical 
craft, and that education should be treated not as an aid, but 
as a palliative of industrialism ; the end is forgotten in the 

means : 

their vision is 
Machines for making more machines. 

The treatment of the rich illustrates the same tendency. 
An artist mav have to wait till he is dead for the fame which 



XXV BUSINESS AND MORALITY 463 

compensates him for poverty ; a prophet is not so much 
without honour as ignored or treated as a joke. The 
millionaire, on the other hand, whether his wealth be the 
reward of real services to the community or the profits of 
a successful corner in wheat or due to the accident of birth, 
has everything that society can give lavished upon him. 
Churches give him the first place in their councils, and 
universities confer degrees upon him. His most casual 
utterances on subjects he does not understand are treasured 
as the words of wisdom ; and the more democratic his 
country is, the easier it is for him to attain to political power. 
How profound, however, is the influence of the economic 
organisation on moral standards is shown perhaps best by the 
usage of ordinary speech. Political idealists speak of the flag, 
the symbol of nationhood, as " the greatest asset " of the 
nation. Political corruption is denounced on the ground that 
it is " bad business." War is deprecated because it no longer 
" pays." Honesty is commended because it is " the best 
policy." We say, in what Gissing called " the vulgarest 
saw that ever disgraced a nation," that " time is money " ; 
we measure a man's worth by his wealth, and say he is 
" worth a million " ; we frankly identify wealth and welfare 
by describing a man as " well off " or " badly off " according 
to his income. Dishonesty, when successful, is admired 
rather than the reverse, as " smartness " ; and the character- 
istics that business develops — self-assertion, keenness, and 
an insensibility to fine scruples and feelings — are the very 
reverse of the humility, content, and self-sacrifice inculcated 
by the professed religion. It was this materialism, or 
" utilitarianism " as Morris called it, " which, being inter- 
preted, means the reckless waste of life in the pursuit of the 
means of life," that the idealists of the nineteenth century, 
Carlyle, Ruskin, and Morris, attacked ; all attributed it to 



464 ECONOMICS chap. 

the same cause, the influence of the economic system 
established by the Industrial Revolution ; and all extended 
their attacks to the economists who explained the system, 
for ignoring the effects of the system on standards of taste 
and conduct. 



Hoiv Wealth contributes to Welfare 

We may now summarise our discussion of wealth and 
welfare, and state such conclusions as can be drawn from it. 
The word "wealth " is used in two senses : in the sense of 
product, the ordinary sense and that in which it is used in 
Economics ; and as meaning welfare, the sense in which 
Ruskin used it. We decided to keep the word " wealth " 
for product and use the word " welfare " for the second 
sense ; the object of our enquiry was to discover the relation 
of wealth to welfare. Wealth, we found, coidd be measured, 
and the best method of procediire seemed to be to enquire 
how far the measure of wealth indicated welfare. 

In the first place, we found the measure of wealth defective, 
since it takes account of so,me kinds of property that are 
not wealth and leaves out of account some forms of wealth 
that do not come into the circle of exchange. Secondly, 
we found the measure of wealth misleading, because the 
value of a thing does not indicate the absolute amount of 
satisfaction the thing gives, depending as value does on 
the distribution of purchasing-power. Thirdly, we found 
that the measure of wealth, strictly in accordance with the 
usage of ordinary speech, takes account only of amount of 
product ; the satisfaction or welfare derived from wealth, 
on the other hand, depends largely on the use of wealth by 
society and the individual, i.e. on distribution and consump- 
tion. In the fourth place, the measure of wealth ignores the 



XXV BUSINESS AND MORALITY 465 

important influence of the economic organisation on welfare^, 
exercised directly through the nature and conditions of 
workj not indirectly through the product. We noted also 
that in some views of welfare wealth was treated as a 
comparatively unimportant if not negligible factor. 

The objection to this enquiry that it was unnecessary 
we decided to be unfounded. The ground of the objection 
was that the economic organisation, owing to freedom of 
enterprise, was responsive to all changes in standards of 
taste and morals, so that the use of productive powers and 
the conditions of production must be the outcome and 
reflection of current conceptions of welfare. On examina- 
tion we found that freedom of enterprise did not necessarily 
make the economic organisation responsive, and that the 
tendency of freedom of enterprise was to make the organisa- 
tion and its products fall below the level of current standards ; 
in any case the economic organisation could not be the 
mere outcome of current conceptions of welfare, because the 
economic organisation reacts on our conceptions of welfare, 
favom^ing the development of certain aims in life and types 
of character, and discouraging others. The influence of the 
present economic system we found was strongly material- 
istic, in the sense that it encouraged reliance on external 
rather than internal sources of satisfaction. 

For the same reason, that the reaction of the economic 
organisation on standards of taste and conduct, and there- 
fore on the whole conception of welfare, is one of the most 
important of the social aspects of business, we put aside 
another objection to our enquiry — the objection, namely, 
that any discussion of the relation of wealth to welfare, 
being an ethical enquiry, was irrelevant to Economics. There 
is, however, a more cogent reason for putting aside the latter 
objection to including a discussion of the relation of wealth 

2h 



466 ECONOMICS chap. 

to welfare in an outline of Economics. Study, at any rate 
economic study, is for action. The immediate object of 
economic action is wealth, but the ultimate object is welfare, 
to which wealth is a means. Unless therefore our economic 
study tells us to what extent and under what circumstances 
an addition to wealth is an addition to welfare, it will not 
help us much in attaining the object of our action. The 
definition of welfare would be an ethical enquiry, but we 
have not attempted such a definition ; all we have tried 
to do is to define wealth, and to show exactly what the 
measure of wealth does measure and what it does not. 
Study is for action, and without such an enquiry we should 
not discover the limits within which economic considerations 
may properly determine action. The practical justification 
of our procedure is that half the discussions of wealth are 
carried on at cross-purposes and lead to nothing, just because 
the parties to them use the word wealth Avithout distinguish- 
ing between its two senses of product and welfare. 

This negative method of stating the relations of wealth 
and welfare was forced upon us by the necessity of avoiding 
in an economic enquiry the ethical question — the question 
of the nature of true welfare. Without committing our- 
selves to a discussion of that difficult and controversial 
question, however, we can state in a positive form the con- 
clusions to which our enquiry points on the relation of 
wealth to welfare. 

Wealth is a means to welfare ; not, according to most 
views of welfare, the only means, but an importaiit means. 
It is a means to welfare in two ways : (1) some wealth is the 
indispensable condition of physical existence, and therefore 
the basis not only of health but of every intellectual and 
spiritual activity ; (2) any addition to wealth above that 
indispensable minimum is a means to welfare by increasing 



XXV BUSINESS AND MOKALITY 467 

man's freedom. It is not necessary to define tlie minimum 
or to mark it ofi by a hard and fast line — it must be allowed 
to include something more than the bare means of sustaining 
physical existence — but the distinction is important. With- 
out the minimum there can be no real freedom, in the sense 
of self-determination ; until it is won, the man's activities 
are all determined for him by his physical needs. And it 
must be secure, or the life that rests upon it, however noble 
and far-reaching its activities, will be built upon an insecure 
foundation. The great service that the Industrial Revolu- 
tion did was, by increasing man's powers of production, 
to put it within the power of society for the first time to 
guarantee to every man this minimum. So long as this 
minimum is insecure, the individual must always be liable 
to worry within and tyranny from without ; for this reason 
security is more important than any addition to wealth, for 
this reason the workers demand a State guarantee of security, 
in the form of " the right to work," in preference to any 
schemes, however generous, of profit-sharing. The dis- 
tinction between this minimum and the surplus of wealth 
is implied in Christian teaching, which enjoins the relief 
of distress while deprecating the pursuit of wealth ; and 
there is nothing materialistic in making the security of 
this minimum for every member of society a chief aim in 
politics. 

Beyond this minimum wealth serves welfare by increasing 
freedom or liberty. Liberty used to be conceived as freedom 
from external control, and in this sense it was the aim of the 
movement which swept away the old system of protection 
and many other restrictions on freedom of action in the 
nineteenth century ; when these had been swept away, 
the great majority of people were still not conscious of 
possessing liberty, and the old negative conception has 

2 H 2 



468 ECONOMICS chap. 

given way to a positive conception, which is best expressed 
by the word opportunity. Wealth gives liberty in this 
sense ; it increases opportunity, giving the possessor more 
choice in the use of his time and fuller means of self-deter- 
mination or self-expression. A man with wealth enough to 
live without working is, we say, " independent " ; a person 
who has to rely on another for all wealth is that person's 
" dependent." The efiect of an increase of wealth upon 
welfare may be neutralised by misuse or waste ; the increase 
must be balanced against any change for the worse in 
conditions of production, and allowance made for the in- 
direct efiects which an increase in one person's wealth may 
have upon other people's welfare. But the increase in 
opportunity remains ; there is a potential increase in welfare. 
The present age might be the richest of all the ages in welfare, 
as it is the richest in wealth. Perhaps it is ; if it is not, it 
is because it has mistaken the means for the end, and treated 
the increase of wealth as an end in itself, instead of con- 
trolling it and directing it in accordance with its general 
conception of welfare. 

VI 

"■ Business is Business " and Economic Laws 

If the view of wealth we have reached is correct, the 
practical conclusion follows, that economic activities are 
subject to the ordinary rules of morality, and the economic 
organisation is to be judged by its conformity to the ordinary 
standards of morality. Moral rules and standards embody 
our conception of welfare, and wealth is only a means to 
welfare. The immediate end of economic activities is 
cheapness, the production of a maximum of wealth with a 
minimum of efiort and sacrifice ; but wealth itself is wanted 



XXV BUSINESS AND MOEALITY 469 

only as a means of welfare, so that economic activities must 
be accounted good or bad according as they promote or 
hinder not wealth merely but welfare. We can separate the 
economic aspect of a social problem for study ; in the 
problem itself the moral and economic aspects are combined, 
and moral considerations are the decisive factor, because 
they embody our conception of the end to which all action 
is directed. To persist in an economic activity therefore, or 
maintain an economic organisation which is contrary to our 
moral sense, is to subordinate the end to the means, or, in 
other words, to sacrifice morality to cheapness. 

It is necessary to point this out, because it conflicts with a 
view of the relation of business to moral rules and standards, 
which is commonly held and not infrequently avowed. Put 
baldly, the view is that business is something outside 
morality, a department of life in which the ordinary rules 
of morality have no validity. The view, however, is seldom 
put baldly ; more frequently it is expressed in the phrase 
" Business is business," and in that form is used to condone 
conduct in business which would be considered dishonom^ing 
in any other relation of life. The view is not so much that 
business ought to be outside the ordinary rules of morality, 
as that it is, the economic organisation being something 
outside man's control, something for the principles of which 
he is not responsible. Just as in nature there is much 
that revolts the moral sense, but is beyond man's control, 
so the oppression, injustice, and " sharp practice" of business 
is supposed to be the inevitable outcome of a " natm-al " 
organisation. In political discussion the view usually 
takes the form of an appeal to certain " natural " or " im- 
mutable " " laws of political economy," which are supposed 
to render futile any eSort to moralise the economic organisa- 
tion by direct social action. 



470 ECONOMICS chap. 

It is not difficult to understand how sucli a view arises. 
The self-interest of the people who profit by the present 
organisation unconsciously inclines them to it. The un- 
conscious identification of wealth and welfare which 
makes people seek wealth for its own sake lends support to 
the view ; it leads people to regard the steady increase of 
wealth as a complete justification of the organisation. The 
belief which we have already examined, that the economic 
organisation under free enterprise responds to every change 
in our standards, and therefore automatically conforms to 
them, leads many people to ignore the problem of moralising 
industry and prevents any protest against the view in 
question. The chief ground of it, however, is the helplessness 
of the individual in the face of the evils of the economic 
organisation. Moral responsibility is personal, the economic 
organisation and its evils are social. The old-fashioned 
duties of charity and probity, that were adequate to a 
simpler economic organisation, are apparently useless in the 
complex organisation of to-day. The individual is part 
of a system that controls him ; competition, the fear of 
losing one's place in the struggle, compels all to toe the 
same line of conduct, and an excess of scruple brings ruin ; 
" things are in the saddle and ride mankind." 

The power of free enterprise to bring the economic 
organisation into conformity with cuiTent morality we have 
seen to be an illusion ; on the contrary, if society does not 
impose its standards of taste and conduct on industry, 
industry will impose its standards on society. The idea that 
the economic organisation is beyond control has even less 
foundation, being due to confusion of thought on the nature 
of what are called " economic laws " and on the relation of 
the economic organisation to these laws. When the " im- 
mutable laws of political economy " are used as an argu- 



XXV BUSINESS AND MOEALITY 471 

ment against any proposal, the impression conveyed is that 
these laws are at one and the same time like natural laws, 
and therefore beyond human control, and like moral or 
statute law, and therefore not to be disobeyed ; the sugges- 
tion intended is that the proposed reform is both futile and 
wicked. 

The " immutability " of economic laws varies ; the phrase 
is applied indiscriminately to all the general tendencies 
that study discovers in the economic organisation, and 
these by no means all belong to the same order. Some 
are tendencies peculiar to the present system of free enter- 
prise, which will cease to operate if the system is changed. 
The so-called " law of monopoly price " is an example ; 
under private enterprise, monopolists tend to fix price and 
output at the level which gives them the biggest return of 
receipts over costs on the total output. Abolish private 
enterprise in monopolies, and you abolish the condition 
on which the " law " depends ; the State will tend to make 
the price as low and the output as large as is possible with- 
out actual loss. The " law of comparative cost " is another 
example ; if trade is free, nations will tend to exchange 
with each other the products of those industries for which 
they have the greatest relative advantages, irrespective of 
ctualcost of production. But this " law " does not make 
protection impossible ; protection, by abolishing free ex- 
change, introduces a new condition. The great law of 
supply and demand belongs to the same order. Under 
free enterprise value depends on supply and demand ; a 
rise in value stimulates supply and checks demand ; a fall 
in value checks supply and stimulates demand. But this 
law does not prevent the State from fixing prices if it wants 
to. If it confines its interference with free enterprise to 
the fixing of prices, the law will still operate ; supply and 



472 ECONOMICS chaj. 

demand will adjust themselves to the prices fixed by tlie 
State. So also with the more important case of fixing the 
price of labour. When the State fixes a legal minimum 
wage it compels no one to employ any worker whose 
contribution to the firm's output is worth less than the 
amount of the wage, it only prevents the employer from 
paying less to the worker whose contribution is worth it ; 
it deliberately prefers to support in some other way those 
workers who cannot earn the minimum and to dispense 
with those industries that cannot pay it. If the State 
wishes, however, it can abolish freedom of enterprise in an 
industry altogether, in which case the law no longer holds 
good ; in the case of military service in a conscript country, 
supply and demand have nothing to do with the wages of 
the soldier. 

Some economic laws, however, are analogous to natural 
laws in being beyond human control ; but the fact that 
they are unalterable does not make the organisation in 
which we discover them unalterable. The law of diminish- 
ing returns in agriculture is immutable ; but that does 
not prevent society, if it wishes, from substituting small 
for large holdings, or public for private ownership of land. 
The tendency in certain manufactures to decreasing cost of 
production as the scale of production increases operates 
independently of the system of control of production ; 
hence the organisation of those manufactures can change 
from private firm to joint-stock company, and from 
company to trust or municipal ownership without the 
" law " offering any obstacle. These unalterable " laws " of 
economics are all based on tendencies of physical nature 
or human psychology ; they are not principles of organisa- 
tion ; they condition the economic organisation, the}^ do 
not determine it in detail. Any system that is to work must 



XXV BUSINESS AND MORALITY 473 

take account of them and adapt itself to them ; but within 
these limits human ingenuity can exercise itself and devise 
any number of organisations. In the present economic 
system we discover many different principles of organisation 
in the production and the distribution of wealth co-existing, 
and none of them seeking to ignore any " law." The laws 
of political economy prevent change in the economic organisa- 
tion no more than the laws of gravity, by which a stone 
released in space will fall, prevent us from building an arch, 
or the fact that the specific gravity of iron is greater than 
that of water prevents us from constructing an iron ship that 
will float. 

VII 

The Moralisation of the Economic Organisation 

The helplessness of the individual in the face of the evils 
of the present economic system is not then due to anything 
" natural " or " immutable " in the system itself. The 
system is the creation of man, and man is responsible for it ; 
if it were really out of his control, it would be his duty at 
any sacrifice of wealth to destroy it and to substitute a 
system he could control. The belief that the economic 
organisation is determined by certain natiu'al laws and 
cannot be changed is a survival from the period of orthodox 
laissez faire. People often think that a thing is impossible 
when they do not want to try to do it, and go on saying 
that it is impossible after it has been tried and done. 
The possibility of changing the economic organisation is 
proved by the changes that have been effected in it. The 
modifications introduced have been conscious attempts to 
bring the economic organisation into conformity with our 
moral ideas, and much has been done to moralise the 
economic system. The methods adopted were the obvious 



474 ECONOMICS chap. 

methods, and can be used to carry the moralising process 
further. 

If society discriminates between different kinds of wealth, 
regarding some as more important and some as less 
important for welfare, the State can give effect to that 
discrimination. It can supply the important forms itself, 
charging the cost in taxes, as it does education and arma- 
ments. It can " socialise consumption " by oft'ering certain 
kinds of wealth for common use, again at the expense of the 
taxes — as it does in the case of pictures in picture galleries, 
recreation grounds in parks, fine architecture in public 
buildings. It can subsidise forms of wealth which private 
enterprise neglects, as classical drama and opera are sub- 
sidised on the Continent. If society discriminates between 
trades and occupations, to this discrimination also the 
State can give effect. It can protect those trades which 
it considers most important, as Germany has protected 
its steel industry and its agriculture ; it can offer indirect 
subsidies, as most Governments do to agriculture ; it can 
adapt its educational system to encouraging the occupa- 
tions it favours, and discouraging those it regards with dis- 
favour ; it can place restrictions on the trades it regards 
as liable to abuse, as restrictions are placed on the sale of 
drink ; it can withhold its protection from contracts, as 
it does from gambling contracts. Similarly, society can 
give effect to any principles it may reach on the value of 
different types of economic organisation by prohibiting 
undesirable forms, as employment of children in factories 
is prohibited, and by imposing limits on freedom of enter- 
prise, to prevent underpayment, overwork, and unhealthy 
conditions. It can diffuse control and responsibility in 
economic life by encouraging those occupations, like 
agriculture, in which small scale enterprise is economical, 



XXV BUSINESS AND MORALITY 475 

by assisting experiments in co-operation, and by entrusting 
the regulation of conditions to trade-associations — which 
is the claim of syndicalism, a claim conceded to the medical 
profession, the legal profession, and the university teaching 
profession. It can promote equality, or at any rate check 
the growing inequality of wealth, by taxation and by laws 
of inheritance. Such a policy may involve some check to 
the growth of vfealth ; it may reduce the total of wealth, 
although it has not done so hitherto ; but the aim of the 
community is welfare, not wealth, and if it decides that 
welfare can be increased at the expense of some wealth it 
has the power to act on its decision. Protection, for 
example, usually involves a reduction in wealth ; it is not 
therefore necessarily bad : whether it is bad or not depends 
on its other efiects. 

Ethical considerations cannot be excluded from economic 
activities. Business, although we can separate it from the 
rest of conduct for the purpose of study, remains a part of 
conduct, and as such is subject to the general rules of con- 
duct. A morality that admitted so large an exception as 
business to its rides would be no morality. The helplessness 
of the individual, acting as an individual, in the face of the 
e^dls of the present economic system, does not absolve him 
of responsibility for them. He benefits by the system : the 
system is capable of change, and the methods by which it 
can be changed are known. What his individual helpless- 
ness points to is the necessity of social action, where 
individual action is inadequate, and his personal responsi- 
bility is discharged only when he has co-operated in such 
social action. 

Doubts of the need and possibility of bringing the 
economic organisation of society into conformity with 
society's general conception of welfare are not the only 



476 ECONOMICS chap, xxv 

obstacle to the attempt ; a greater obstacle is the divergent 
conceptions of welfare that are held, not only by difierent 
churches and parties, but even within the same chm'ch 
or party. Ruskin felt this so strongly that he thought the 
primary business of political economy should be to answer 
the ethical question, " What is Welfare ? " or " Wealth," as 
he called it. With that divergence we are not concerned, 
except to note that it is only in the light of such a general 
conception that we can value and judge competing types 
of economic organisation and different objects of economic 
activity ; and to remember that while we can separate the 
economic and the ethical aspects of a problem for the purpose 
of study^ in the problem itself they are combined — ^we cannot 
separate them for action. 



THE END 



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